Corporate Debt Maturity and Business Cycle Fluctuations

Francesco Ferrante, Andrea Prestipino and Immo Schott
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Immo Schott: https://www.federalreserve.gov/econres/immo-schott.htm

No 1409, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: Long-term debt is the main source of firm-financing in the U.S. We show that accounting for debt maturity is crucial for understanding business cycle dynamics. We develop a macroeconomic model with defaultable long-term debt and equity adjustment costs. With long-term debt, firms have an incentive to increase leverage in order to dilute the value of outstanding debt. When equity issuance is costly, this incentive helps firms raise more debt through a debt dilution channel and mitigates the decline in net worth through a balance sheet channel, dampening the decline in investment in response to a negative financial shock. Using firm-level data, we estimate equity issuance costs and incorporate our findings into an estimated medium-scale DSGE model. Accounting for debt maturity and the cost of equity financing implies that credit supply shocks are the primary drivers of business cycle fluctuations.

Keywords: Long-term debt; Financial frictions; Debt overhang; Macroeconomic activity (search for similar items in EconPapers)
JEL-codes: E32 E44 E51 (search for similar items in EconPapers)
Date: 2025-05-27
New Economics Papers: this item is included in nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgif:1409

DOI: 10.17016/IFDP.2025.1409

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