The rise in corporate debt over the last decade has led to increased concerns about risks to financial stability and economic growth, as highly indebted firms are more likely to default in the event of an economic downturn. However, elevated corporate debt can influence a firm’s decision-making even in the absence of financial stability risks. Debt service payments reduce net income that could otherwise finance future investment, and higher debt levels drive credit costs up as default risk rises, incentivizing firms to invest in riskier projects. In addition, some investors may be unwilling to finance new firm investments if they fear that any investment returns will accrue only to senior debt holders.
W. Blake Marsh, David Rodziewicz, and Karna Chelluri examine the relationship between high corporate leverage and future firm spending on structures, machinery, and equipment. They find that, on average, more leveraged firms across industries tend to have lower levels of investment activity in the future. This negative relationship between debt and investment is strongest for the most highly indebted firms and is evident in both economic downturns and expansions.
Publication information: Vol. 5, no. 1