Corporate debt structure and the macroeconomy∗

The composition of corporate borrowing between bank loans and market debt varies substantially, both across countries and over the business cycle. This paper develops a new model of firm dynamics, where firms choose both the scale and composition of their borrowing, in order to understand the aggregate implications of variation in debt structure. Banks are assumed to differ from markets in their ability to restructure debt payments when a firm is in financial distress; however, banks ’ flexibility in distress comes at the expense of tougher lending standards. The steady-state of the model is consistent with key cross-sectional facts about debt composition: in particular, firms simultaneously use bank loans and market debt, and the share of bank loans in total debt is negatively related to its net worth. Over the business cycle, I show that asymmetric shocks to banks ’ lending costs generate substitution from bank loans to market debt, as in the US during the 2007–2009 recession. Additionally, these shocks have magnified effects if the economy is initially more bank-reliant. For example, the recession they generate is 15–30 % deeper in a version of the model calibrated to Europe than in one calibrated to the US. I then study the macroeconomic effects of corporate finance policies aimed at encouraging market debt financing by small and medium-sized firms. While these policies stimulate investment of small firms, they also induce mid-sized firms to adopt a debt structure that increase