Abstract
Considerable research focuses on the aggregate impact of debt financing. We show that equity is empirically more important for firm growth than generally understood. An extra dollar of equity issuance is associated with an extra $0.93 of real assets, whereas an extra dollar of debt issuance is associated with an extra $0.14 of real assets. Firms issue equity first, then increase real assets, and finally issue debt while repurchasing equity. We explain this sequence using a model in which debt is tax preferred relative to equity but is subject to limited commitment. In the model, firms initially issue equity to finance investments. After they obtain assets that can be pledged to lenders, firms substitute debt for equity to benefit from interest tax deductions. We estimate the model and use it to evaluate the effect of several government policies on corporate growth through their impact on the sources of financing.
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