The Nature of Firm Financing and Growth

Using the universe of incorporated firms in the United Kingdom, we document that long term debt that is not secured by specific corporate assets (commonly referred to as cash-flow-based debt) is ubiquitous, even among very young firms. Consistent with cash-flow-based lending depending on firms' continuation value, both the timing and the amount of cash-flow-based debt at first financing are strongly related to future performance. In fact, the age at which firms first access cash-flow-based long-term debt is a strong predictor of firm outcomes up to twenty years later. In contrast, the age at which firms access asset-based lending does not predict future performance. To understand how lending based on continuation value impacts firm dynamics, we develop a tractable theory of firm life cycle dynamics with permanent heterogeneity and financing frictions -- where access to finance can be based on signals of both current and future performance. The model highlights the importance of financing based on future value in matching the predictability of cash-flow-based financing observed in the data. It also highlights how frictions to financing based on available collateral vs. future value lead to differential selection and hence very different distributions of firms that survive and grow. The degree to which firms can access financing based on future value is therefore fundamentally intertwined with aggregate firm dynamics.