Investment and the Cost of Capital: New Evidence from the Corporate Bond Market

42 Pages Posted: 27 Jun 2007 Last revised: 2 Jul 2010

See all articles by Simon Gilchrist

Simon Gilchrist

Boston University - Department of Economics; National Bureau of Economic Research (NBER)

Egon Zakrajsek

Federal Reserve Board - Division of Monetary Affairs

Date Written: June 2007

Abstract

We study the effect of variation in interest rates on investment spending, employing a large panel data set that links yields on outstanding corporate bonds to the issuer income and balance sheet statements. The bond price data -- based on trades in the secondary market -- enable us to construct a firm-specific measure of the user cost of capital based on the marginal cost of external finance as determined in the market for long-term corporate debt. Our results imply a robust and quantitatively important effect of the user cost of capital on the firm-level investment decisions. According to our estimates, a 1 percentage point increase in the user cost of capital implies a reduction in the investment rate of 50 to 75 basis points and, in the long run, a 1 percent reduction in the stock of capital.

Suggested Citation

Gilchrist, Simon and Zakrajsek, Egon, Investment and the Cost of Capital: New Evidence from the Corporate Bond Market (June 2007). NBER Working Paper No. w13174. Available at SSRN: https://ssrn.com/abstract=994223

Simon Gilchrist (Contact Author)

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Egon Zakrajsek

Federal Reserve Board - Division of Monetary Affairs ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-728-5864 (Phone)
202-452-3819 (Fax)

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