The Firm-Level Credit Multiplier

Abstract:     
We study the effect of asset tangibility on corporate financing and investment decisions. Financially constrained firms benefit the most from investing in tangible assets because those assets help relax constraints, allowing for further investment. Using a dynamic model, we characterize this effect - which we call firm-level credit multiplier - and show how asset tangibility increases the sensitivity of investment to Tobin’s Q for financially constrained firms. Examining a large sample of manufacturers over the 1971–2005 period as well as simulated data, we find support for our theory’s tangibility–investment channel. We further verify that our findings are driven by firms’ debt issuance activities. Consistent with our empirical identification strategy, the firm-level credit multiplier is absent from samples of financially unconstrained firms and samples of financially constrained firms with low spare debt capacity.

Number of Pages in PDF File: 50

Keywords: Credit Multiplier, Capital Structure, Financing Constraints, Investment, Real Options

JEL Classification: G31, G32

Accepted Paper Series