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Leverage as a State Variable for Employment, Inventory Accumulation, andFixed Investment

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Author Info
Charles W. Calomiris
Athanasios Orphanides
Steven A. Sharpe

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Abstract

The importance of a firm's balance sheet for determining its investment and employment decisions is the central assumption of macroeconomic models of 'debt deflation' or 'debt overhang.' According to these models, firm investment decisions are influenced not only by the fundamental opportunity set of the firm, but also by the firm's existing financial condition, especially its leverage. This paper tests that assumption by examining whether the responsiveness of employment, investment, and inventory accumulation to exogenous changes in sales depend on the leverage of the firm. We find that leverage acts as an important state variable for conditioning the response of all three variables to changes in sales. We also find that this effect varies depending on the state of the economy. During recessions, higher leverage magnifies the contractionary effect of declines in sales on investment; during times of positive sales growth, higher leverage tends to dampen the expansionary effect of growth in demand. The size and significance of leverage conditioning effects are larger during recessions. These results support theoretical models of the potential importance of 'debt overhang' effects. Firms that use debt to finance expansion during times of increasing demand suffer reduced ability to maintain growth during recessions as a consequence of their higher leverage.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4800.

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Date of creation: Jul 1994
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Handle: RePEc:nbr:nberwo:4800

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Marianne Gizycki, 2001. "The Effect of Macroeconomic Conditions on Banks’ Risk and Profitability," RBA Research Discussion Papers rdp2001-06, Reserve Bank of Australia. [Downloadable!]
  2. Zyblock, Miles, 1997. "L'effet de levier financier des entreprises : une comparaison entre le Canada et les É.-U., 1961-1996," Direction des études analytiques : documents de recherche 1997111f, Statistics Canada, Direction des études analytiques. [Downloadable!]
  3. Philip Vermeulen, 2000. "Business fixed investment: evidence of a financial accelerator in Europe," Working Paper Series 37, European Central Bank. [Downloadable!]
    Other versions:
  4. Heisz, Andrew & Larochelle-Côté, Sébastien, 2004. "Corporate Financial Leverage in Canadian Manufacturing: Consequences for Employment and Inventories," Analytical Studies Branch Research Paper Series 2004217e, Statistics Canada, Analytical Studies Branch. [Downloadable!]
  5. Tobias Miarka & Michael Tröge, 2005. "Do bank-firm relationships reduce bank debt? Evidence from Japan," European Journal of Finance, Taylor and Francis Journals, vol. 11(1), pages 75-92, February. [Downloadable!] (restricted)
  6. Simon Gilchrist & Charles Himmelberg, 1998. "Investment, Fundamentals and Finance," NBER Working Papers 6652, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  7. Michael Funke & Holger Strulik, 1998. "Leverage as a Conditioning Variable for Employment: An Analysis of a Panel of West German Manufacturing Firms," Quantitative Macroeconomics Working Papers 19804, Hamburg University, Department of Economics. [Downloadable!]
  8. Zyblock, Miles, 1997. "Corporate Financial Leverage: A Canada - U.S. Comparison, 1961-1996," Analytical Studies Branch Research Paper Series 1997111e, Statistics Canada, Analytical Studies Branch. [Downloadable!]
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