A hidden cost of progress: Digital infrastructure can increase corporate borrowing costs

Background and Motivation

In an era of global digital transformation, governments worldwide are investing heavily in digital infrastructure, anticipating widespread economic benefits, including improved efficiency and market access. While the positive impacts on connectivity and information flow are well-documented, the nuanced effects on corporate finance, particularly the cost of private debt, remain less explored. This study was motivated by the need to understand the full spectrum of consequences that large-scale digital infrastructure projects have on the financial strategies and pressures faced by firms.

Methodology and Scope

To establish a clear causal link, the researchers employed a robust quasi-experimental approach. They treated China's national "Broadband China" strategy—a policy that rolled out and upgraded broadband infrastructure across different cities at different times—as a natural experiment. Using a difference-in-differences (DID) method, the team compared the cost of debt for firms in cities where the policy was implemented against those in cities where it was not, both before and after the implementation. This methodology allows researchers to isolate the effect of the digital infrastructure shock from other economic factors.

Key Findings and Contributions

• Higher Borrowing Costs: Contrary to expectations, the study found that digital infrastructure construction leads to a statistically significant increase in firms' borrowing costs. This finding was consistent across multiple robustness checks.
• The Root Cause: Intensified Competition: The primary mechanism driving this increase is intensified market competition. As digital infrastructure lowers entry barriers and increases market transparency, it fosters a more competitive landscape. This heightened competition, in turn, elevates a firm's operational risk in the eyes of lenders, who respond by charging higher interest rates on debt.
• Disproportionate Impact: The effect is not uniform across all businesses. The increased cost of debt is more pronounced for non-state-owned enterprises (non-SOEs) and smaller firms, which are typically more vulnerable to competitive pressures and have less access to stable financing.
• Impact on Fundamentals: Additional evidence indicates that digital infrastructure construction can also lead to a decrease in firm fundamentals, such as profitability, further explaining the heightened risk perception among lenders.

Why It Matters

This research provides a critical and nuanced perspective on the ongoing global push for digitalisation. It demonstrates that the economic effects of such policies are complex and can have unintended financial consequences. For investors and lenders, it highlights how technological shifts can alter a firm's risk profile. For managers, especially in non-SOEs and SMEs, it underscores the urgent need to develop strategies to thrive in a more digitally connected and intensely competitive environment.

Practical Applications

• For Policymakers: Governments should be aware that while digital infrastructure is crucial, it may create short-to-medium-term financial strain for the very firms—private and small businesses—that are often drivers of innovation and employment. Complementary policies, such as targeted financial support or business development programs, may be needed to help these firms adapt and mitigate rising financing costs.
• For Corporate Managers: Firms, particularly non-SOEs and SMEs, must proactively enhance their competitive advantages and operational efficiency. In a digitally transformed market, demonstrating resilience and a clear strategy to lenders will be key to securing favourable borrowing terms.
• For Financial Institutions: Lenders can use these insights to refine their risk assessment models, recognising that a firm's location and exposure to digitally intensified markets are now significant factors in credit evaluation.

Discover high-quality academic insights in finance from this article published in China Finance Review International. Click the DOI below to read the full-text!