Investment and Financing Sensitivity of Large versus Small Firms to Industry Growth Shocks

Abstract

We examine the response of firm-level capital investment and financing policies to persistent industry-specific growth shocks, while controlling for the effect of aggregate shocks. A striking empirical finding is that investment of large firms is more sensitive to industry-specific shocks compared to that of smaller firms, whereas small firms exhibit greater investment sensitivity to aggregate shocks compared to large firms. Our empirical results are consistent with optimal investment and financing behavior of firms in a dynamic model of investment and financing that accounts for the growth potential of industry-specific shocks separately from the general impact of aggregate shocks on profits.

Keywords: Industry business cycle, capital investment, financing, manufacturing

JEL Classification: E32, G31, G32