Do Peer Firms Affect Corporate Financial Policy

We show that corporate financial policies are highly interdependent; firms make financing decisions in large part by responding to the financing decisions of their peers, as opposed to changes in firm-specific characteristics. We identify these peer effects with a novel instrumental variables approach that uses the idiosyncratic equity shocks to peer firms as a source of exogenous variation. On average, a one standard deviation change in peer firms ’ leverage ratios is associated with a 9% change in own firm leverage ratios — a marginal effect that is significantly larger than that of any other observable determinant and one that is driven by underlying interdependencies among security issuance decisions. The presence of these peer effects creates an externality among financial policies that amplifies the effect of changes in firm-specific characteristics by over 11%, and transmits these changes onto the financial policies of other firms. Competitor, or peer, firms play a central role in shaping a variety of corporate poli-cies ranging from executive compensation to product market strategy. However, mos