Firm Financing Over the Business Cycle

Firm Financing Over the Business Cycle

By
Juliane Begenau, Juliana Salomao
Review of Financial Studies. April
2019, Vol. 32, Issue 4, Pages 1235-1274

Data from U.S. public firms show that in booms large firms finance with debt and payout equity, whereas small firms issue both equity and debt. Therefore, large firms generally substitute between debt and equity financing over the business cycle, whereas small firms adhere to a procyclical financing policy for debt and equity. We explain these cyclical financing patterns quantitatively using a heterogeneous firm model with endogenous firm dynamics. We find that cross-sectional differences in investment returns and, therefore, funding needs and exposures to financial frictions are essential to understanding how firms’ financing policies respond to macroeconomic shocks.