Credit Supply and Corporate Policies

Abstract

This paper develops a model of corporate investment and financing decisions that differs from previous contributions by recognizing that firms may face uncertainty regarding their future access to credit markets. We show that accounting for credit supply uncertainty is critical in understanding corporate policy choices and use the model to explain a key set of stylized facts in corporate finance. Notably, our model provides an explanation for the conservative debt policy puzzle. The model also explains why firms may appear to time the market when issuing common stock. Finally, the model explains why negative shocks to the supply of credit may hamper investment even if firms have enough financial slack to fund all profitable investment opportunities internally.

Keywords: Corporate investment, capital structure, credit supply, real options, search