Financing Cycles

Abstract

Capital ages and must eventually be replaced. We propose a theory of financing in which firms finance new capital with debt and optimally deleverage to free up debt capacity as their capital ages, thereby generating debt cycles. Concurrently, firms shorten the maturity of their debt to match the remaining life of their capital, generating maturity cycles. These firm-level financing cycles drive aggregate leverage and maturity dynamics when capital age is correlated across firms. We provide time series and cross-sectional evidence that strongly supports these independent predictions and highlights the key roles of capital age and asset life in financing cycles.

Keywords: capital structure, leverage, debt maturity, capital age, financing cycles

JEL Classification: E32, G31, G32