DP17845 Corporate Investment and Financing Dynamics
We consider the behavior of leverage ratios in a trade-off model with investment. Debt underutilization to retain financial flexibility persists even when firms exercise their last investment options, and it is more (less) severe for more back-loaded (front-loaded) investment opportunities. Leverage paths crucially hinge upon the structure of the investment process, which leads firms to have significantly different target leverage ratios. Structural estimation of key parameters reveals that simulated model moments can match data moments. In simulated panels, leverage regression results are in line with the empirical evidence, and average leverage ratios are path-dependent and persistent for extended periods of time.