Evidence for a Debt Financing Channel in Corporate Investment

Abstract

In the simplest frictionless theory, an increase in interest rates causes a symmetric decline in investment for all firms because they discount new projects at a higher cost of capital. I develop and test a specific debt-market financing channel that predicts cross-sectional differences in the response of investment to interest rates. Firms with high levels of short-term debt suffer a decline in net worth, relative to firms financed with long-term debt, when nominal interest rates increase. When collateral constraints are binding, these firms reduce investment relative to the frictionless benchmark. In U.S. firm-level data between 1953 and 2001, the investment of firms with a high current portion of debt is more sensitive to interest rates when compared with firms that have little debt or only long-term debt. Consistent with my predictions, firms with high levels of short-term debt also display higher investment sensitivity to inflation.