Corporate debt booms, financial constraints, and the investment nexus

Abstract

SummaryHow do corporate debt booms affect investment? Using US firm‐level data over 1984Q1–2019Q4, and an instrument for firm‐specific debt booms that exploits systematic differences in firms' exposure to industry‐level debt booms, I find that debt booms cause investment growth to decline over the medium term. This result is driven by the financial constraints channel: Vulnerable firms experience a higher cost of debt in the short run, lower stock returns, and an increase in indicators proxying financial risk. Vulnerable firms also cut their investment spending after a debt boom, irrespective of their growth opportunities. Finally, I find that congestion effects from vulnerable firms on healthy firms are amplified during debt booms, stressing the risk that debt booms in a subset of firms may spill over to the rest of the economy.