Corporate credit booms, financial constraints, and the investment nexus

Abstract

Does corporate debt overhang affect investment over the medium term? To better uncover this association, I argue that we need to measure debt overhang with a concept of debt accumulation or debt boom, and to combine leverage with liquid assets to capture financial constraints. Using firm-level data for a large panel of US non-financial firms over 1985Q1-2019Q1, I find that debt overhang leads financially vulnerable firms – high debt and low liquid asset holdings – to cut back on investment: a 10 p.p. increase in the three-year change in the leverage ratio is associated with 5% lower capex investment after five years compared to the most resilient firms. I also find that vulnerable firms experience weaker intangible capital growth in the aftermath of debt booms. Finally, I find that general equilibrium effects dominate, stressing the risk that firm-specific debt booms in a subset of firms may spill over to the rest of the economy.