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The Role of Debt and Equity Finance over the Business Cycle

Francisco Covas () and Wouter Den Haan
Authors registered in the RePEc Author Service: Wouter Denhaan ()

No 6145, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper documents that debt and equity issuance are procyclical for most size-sorted firm categories of listed U.S. firms. The procyclicality of equity issuance decreases monotonically with firm size. At the aggregate level, however, the results are not conclusive. The reason is that issuance is countercyclical for very large firms which, although few in number, have a large effect on the aggregate because of their enormous size. We show that the shadow price of external funds is procyclical if firms use the standard one-period contract. This model property generates procyclical equity and - as in the data - the procyclicality decreases with firm size. Another factor that causes equity to be procyclical in the model is a countercyclical cost of equity issuance. The calibrated model (i) generates a countercyclical default rate, (ii) generates a stronger cyclical response for small firms, and (iii) magnifies shocks, whereas the model without equity as an external financing source does the exact opposite.

Keywords: agency problems; firm heterogeneity; magnification (search for similar items in EconPapers)
JEL-codes: E32 E44 (search for similar items in EconPapers)
Date: 2007-02
New Economics Papers: this item is included in nep-bec, nep-dge, nep-fmk and nep-mac
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Related works:
Journal Article: The Role of Debt and Equity Finance Over the Business Cycle (2012) Downloads
Working Paper: The Role of Debt and Equity Finance over the Business Cycle (2006) Downloads
Working Paper: The role of debt and equity finance over the business cycle (2006) Downloads
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