Earnings-Based Borrowing Constraints and Macroeconomic Fluctuations

Micro evidence on US corporate borrowing suggests a strong connection between firms' current earnings and their access to debt. This paper formalizes this link through an earnings-based constraint on firm borrowing and studies its macroeconomic implications. Introducing the proposed constraint in a business cycle model alters the transmission of shocks relative to an asset-based collateral constraint, which has become a standard building block in macroeconomics. In response to positive investment shocks, corporate debt expands when earnings-based constraints are present, while it contracts with collateral constraints, as the shock reduces the relative value of capital. The paper empirically verifies these theoretical predictions using both aggregate and firm-level data. The responses of debt to investment shocks in the data support the aggregate relevance of the earnings-based constraint, and heterogeneous borrowing dynamics at the firm-level are in line with the mechanism. In an estimated quantitative model with nominal rigidities, earnings-based constraints dampen the output response to fiscal shocks, whereas monetary shocks have stronger but less persistent effects relative to counterfactual estimations without the constraint.