Business Shocks and Corporate Leverage
54 Pages Posted: 30 Jan 2017 Last revised: 30 Jul 2021
Date Written: June 21, 2021
We examine whether and to what extent business shocks explain the puzzling instabilities of corporate leverage. We find that business shocks explain a large portion of the unexplained leverage deviation, cross-sectional leverage position migration, and evaporating leverage similarities in the cross-section of firms. The cross-sectional distribution of corporate leverage is relatively persistent when there are fewer and smaller business shocks but becomes unstable for firms with larger business shocks. Our findings suggest that business shocks lead to discontinuities in the corporate value creation process and investment, thereby affecting corporate financing decisions. Put simply, the lumpiness of investment creates a "lumpy" need for external financing. Our analysis implies that the empirical modeling of capital structure adjustment and, indeed, the modeling of other corporate policies, should be conditioned on business shocks.
Keywords: Capital Structure, Business Shocks
JEL Classification: G32
Suggested Citation: Suggested Citation