Working Paper: CEPR ID: DP6145
Authors: Francisco Covas; Wouter Den Haan
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
JEL Codes: E32; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Debt and equity issuance (G32) | Procyclical behavior (E32) |
| Firm size (L25) | Procyclicality of equity issuance (G24) |
| Shadow price of external funds (G19) | Procyclical equity issuance (G24) |
| Countercyclical cost of equity issuance (G24) | Procyclical behavior of financing sources (E44) |
| Firm size (L25) | Stronger cyclical response (E32) |
| Calibration of model (C52) | Countercyclical default rate (E32) |
| Calibration of model (C52) | Magnified shocks (E32) |
| Very large firms (L25) | Ambiguous results in aggregate data (C80) |