Corporate debt booms, financial constraints, and the investment nexus

Abstract

How do corporate debt booms affect investment? Using US firm-level data over 1984Q1-2019Q4,
and an instrument for firm-specific debt booms that exploits systematic differences in firms' exposure to industry-level debt booms, I find that debt booms cause investment growth to decline over the medium term. This result is driven by the financial constraints channel: vulnerable firms experience a higher cost of debt in the short run, lower stock returns, and an increase in indicators proxying financial risk. Vulnerable firms also cut their investment spending after a debt boom, irrespective of their growth opportunities. Finally, I find that congestion effects from vulnerable firms on healthy firms are amplified during debt booms, stressing the risk that debt booms in a subset of firms may spill over to the rest of the economy.

Keywords: Corporate debt booms; Firm investment; Financial constraints; Local projections; Instrumental variable approach

JEL Classification: C36, D22, E22, E32, G32