This paper develops a structural equilibrium model with intertemporal macroeconomic risk, incorporating the fact that firms are heterogeneous in their asset composition. Compared to firms that are mainly composed of invested assets, firms with growth options have higher costs of debt because they are more volatile and have a greater tendency to default during recession when marginal utility is high and recovery rates are low. Our model matches empirical facts regarding credit spreads, default probabilities, leverage ratios, equity premiums, and investment clustering. Importantly, it also makes predictions about the cross-section of all these features.Keywords: Asset composition, capital structure, credit spread puzzle, equity premium, growth options, macroeconomic risk, value premium $ We thank an anonymous referee whose suggestions have greatly improved the paper.

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This paper develops a structural equilibrium model with intertemporal macroeconomic risk, incorporating the fact that firms are heterogeneous in their asset composition. Compared to firms that are mainly composed of invested assets, firms with growth options have higher costs of debt because they are more volatile and have a greater tendency to default during recession when marginal utility is high and recovery rates are low. Our model matches empirical facts regarding credit spreads, default probabilities, leverage ratios, equity premiums, and investment clustering. Importantly, it also makes predictions about the cross-section of all these features.Keywords: Asset composition, capital structure, credit spread puzzle, equity premium, growth options, macroeconomic risk, value premium $ We thank an anonymous referee whose suggestions have greatly improved the paper.

This paper analyzes the decision of firms to sell assets to fund investments (financing asset sales). For a sample of U.S. manufacturing firms during the 1971-2010 period, we document new stylized facts about financing asset sales that cannot be explained by traditional motives for selling assets, such as financial distress or financing constraints. Using a structural model of financing, investment, and macroeconomic risk, we show that financing asset sales attenuate the debt overhang problem, because asset sale financed investments imply lower wealth transfers from equity to debt than otherwise identical but equity financed investments. This novel motive to reduce the debt overhang problem can explain how financing asset sales relate to firm characteristics and business cycles. We also confirm with simulated panels of model firms that are structurally similar to their empirical counterpart that they indeed feature the dynamic patterns of financing asset sales we observe in the data for real firms.