Corporate Investment and Financing over the Industry Business Cycle

61 Pages Posted: 27 Apr 2020

See all articles by Praveen Kumar

Praveen Kumar

University of Houston - Department of Finance

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business

Date Written: March 31, 2020

Abstract

How do firms vary their capital investment and financing policies in response to business cycle fluctuations within their industry? To address this question, we use the regime-switching approach to compute the quarterly time-series of the probability of a future industry downturn for industry groups within the U.S. manufacturing sector. After controlling for the aggregate business cycle, we find that firm-level capital investment and debt issuance are procyclical, whereas net equity issuance and cash accumulation are countercyclical over the industry business cycle. However, there is substantial heterogeneity across firms based on size and credit rating. The effects of the industry business cycle are often larger than that of the aggregate business cycle, and including the former in the analysis changes the relationships between firm-level financing policies and aggregate business cycle documented in previous studies. We show that extending the standard dynamic trade-off model to incorporate heterogeneous effects of industry and aggregate business cycles can help explain the empirical findings.

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

JEL Classification: E32, G31, G32

Suggested Citation

Kumar, Praveen and Yerramilli, Vijay, Corporate Investment and Financing over the Industry Business Cycle (March 31, 2020). Available at SSRN: https://ssrn.com/abstract=3567451 or http://dx.doi.org/10.2139/ssrn.3567451

Praveen Kumar

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)

Vijay Yerramilli (Contact Author)

University of Houston, C. T. Bauer College of Business ( email )

Houston, TX 77204
United States
713-743-2516 (Phone)

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