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We examine whether sharp debt increases through leveraged buyouts and recapitalizations interact with market structure to influence plant closing and investment decisions of recapitalizing firms and their rivals. We take into account the fact that recapitalizations and investment decisions are both endogenous and may be simultaneously influenced by the same exogenous events. Following their recapitalizations, firms in industries with high concentration are more likely to close plants and less likely to invest. Rival firms are less likely to close plants and more likely to invest when the market share of leveraged firms is higher. We are grateful to David Denis, Owen Lamont, Peter MacKay, Vojislav Maksimovic,

This essay surveys the body of research that asks how the efficiency of corporate investment is influenced by problems of asymmetric information and agency. I organize the material around two basic questions. First, does the external capital market channel the right amount of money to each firm? That is, does the market get across-firm allocations right, so that the marginal return to investment in firm i is the same as the marginal return to investment in firm j? Second, do internal capital markets channel the right amount of money to individual projects within firms? That is, does the internal capital budgeting process get withinfirm allocations right, so that the marginal return to investment in firm i’s division A is the same as the marginal return to investment in firm i’s division B? In addition to discussing the theoretical and empirical work that bears most directly on these questions, the essay also briefly sketches some of the implications of this work for broader issues in both macroeconomics and the theory of the firm.

This paper provides a competitive equilibrium model of capital structure and industry dynamics. In the model, firms make financing, investment, entry, and exit decisions subject to idiosyncratic technology shocks. The capital structure choice reflects the tradeoff between the tax benefits of debt and the associated bankruptcy and agency costs. The interaction between financing and production decisions influences the stationary distribution of firms and their survival probabilities. The analysis demonstrates that the equilibrium output price has an important feedback effect. This effect has a number of testable implications. For example, high growth industries have relatively lower leverage and turnover rates. THE INTERACTION BETWEEN CAPITAL STRUCTURE and product market decisions has recently received considerable attention in both economics and finance. Beginning

Evidence from business cycles!

We examine how intra-industry variation in financial structure relates to industry factors and whether real and financial decisions are jointly determined within competitive industries. We find that industry and group factors beyond standard industry fixed effects are also important to firm financial structure. Firm financial leverage, capital intensity, and cash-flow risk are interdependent decisions that depend on the firm’s proximity to the median industry capital-labor ratio, the actions of firms within its industry quintile, and its status as entrant, incumbent, or exiting firm. Our results support competitive industry equilibrium models of financial structure in which debt, technology, and risk are simultaneous decisions.

This paper presents the ¢rst model where entry deterrence takes place through ¢nancial rather than product-market channels. In existing models, a ¢rm’s choice of ¢nancial instruments deters entry by a¡ecting product market behavior; here entry deterrence occurs by a¡ecting the credit market behavior of investors towards entrant ¢rms.We ¢nd that to deter entry, the claims held on incumbent ¢rms should be su⁄ciently risky, that is, equity. This contrasts with the standard Brander and Lewis (1986) result that debt deters entry.This e¡ect is more marked the less competitive the credit market isFso more credit market competition spurs more product market competition. The di⁄culties inherent in acquiring external ¢nance in the United States in the nineteenth century provide an explanation for the basis of the fortunes of certain American entrepreneurs and suggest at least one reason why the economy was characterized by increasing concentration in the growth sectors.

This paper empirically studies how corporate cash holdings affect product market decisions. Using U.S. intra-industry data from 1971 to 2005, the analysis reveals that larger relative-to-rivals cash reserves lead to systematic future market share gains that obtain at the expense of industry rivals. Noteworthy, this “competitive ” effect of cash turns out to be magnified when rivals face tighter financing constraints and when firms intensively interact in their product market. From a different perspective, the analysis further demonstrates that firms ’ cash policy plays a significant pre-emptive role that distorts rivals ’ financial and real decisions. Specifically, consistent with a deterrence effect of deep pockets, I find that incumbents ’ cash reserves significantly curb the entry of potential competitors. In a similar vein, cash holdings considerably hamper the expansion of rivals by constraining both their investment and acquisition policies. Overall, my results provide compelling evidence firm’s cash policy encompasses a substantial and valuable strategic dimension

Market power in the hands of a supplier — such as a labor union — affects a firm’s optimal debt policy. If a firm maintains a high level of liquidity, workers may be encouraged to raise wage demands. In the presence of external finance constraints, a firm has an incentive to use the cash flow demands of debt service payments to improve its bargaining position. Using both cross-sectional estimates of firm-level collective bargaining coverage as well as state changes in labor law to identify changes in union bargaining power, I show that firms indeed appear to use financial leverage strategically to influence collective bargaining negotiations. These estimates suggest that strategic incentives from union bargaining have a substantial impact on financing decisions.

Numerous theoretical models show how management incentive schemes can reduce the distortionary effects of financial leverage. However, there is little empirical support for the models ’ prediction that highly levered firms should offer less stock-based compensation. We stress that the incentive effects of financial leverage can be directly offset by adjusting the exercise price of executive stock options, and that the standard practice of setting exercise prices near the prevailing stock price accomplishes much of the necessary adjustment. In a large sample of Canadian option-granting firms, we find no evidence that risk-taking incentives are increased by financial leverage. This is true both cross-sectionally and over time. JEL Classification Numbers G32, D23, J33Financial structure can affect real decisions through two distinct channels. First, debt obligations restrict the flow of funds into the firm 1. Second, as argued by Jensen and Meckling (1976), financial leverage induces shareholders to favor risky projects even if such projects reduce total firm value. 2 Haugen and Senbet (1981) were the first to point out that financial leverage will not distort risk choices if managers ’ incentives differ appropriately from those of