Growth opportunities and corporate debt policy: the case of the U.S. defense industry

Abstract

The U.S. defense industry provides a natural experiment for examining how changes in growth opportunities affect the level and structure of corporate debt. The growth opportunities of defense firms, compared with other firms, increased substantially during the Reagan defense buildup of the early 1980s but then declined significantly with the end of the cold war and associated defense budget cuts in the late 1980s and early 1990s. We examine how the level and structure of corporate debt changed for a sample of 61 defense firms and a benchmark sample of 61 manufacturing firms during 1980–95, a period spanning the changes in growth opportunities. The debt levels of weapons manufacturers, which were most affected by the changes in growth opportunities, increased significantly as their growth opportunities declined. In addition, these firms lengthened the maturity structure of their debt, decreased the ratio of private to public debt, and decreased the use of senior debt as their growth opportunities declined. The results complement other studies that have found cross-sectional relations between proxies for growth opportunities and leverage variables and validate the prominent role played by growth opportunities in the theory of corporate finance.