Capital structure and product markets interactions: Evidence from business cycles

This paper provides firmand industry-level evidence on the effects of capital structure on product market outcomes for a large cross-section of industries over a number of years. The analysis uses shocks to aggregate demand as surrogates for exogenous changes in the product market environment. I find that debt financing has a negative impact on firm (relative-to-industry) sales growth in industries where rivals are relatively unlevered during recessions, but not during booms. In contrast, no such effects are observed for firms competing in high-debt industries. At the industry level, I find that markups are more countercyclical when industry debt is high. The cyclical dynamics I find for firm sales growth and for industry markups are consistent with Chevalier and Scharfstein’s (1996) prediction that firms that rely heavily on external financing are more likely to cut their investment in market share building in response to negative shocks to demand, and that the competitive outcomes resulting from such actions depend on the financial structures of their rivals. JEL classification: G32; D43; E32