Do Peer Firms Affect Corporate Financial Policy

We show that peer firms play an important role in determining corporate capital structures and financial policies. In large part, firms ’ financing decisions are responses to the financing decisions and, to a lesser extent, the characteristics of peer firms. These peer effects are more important for capital structure determination than most previously identified determinants. Furthermore, smaller, less successful firms are highly sensitive to their larger, more successful peers, but not vice versa. We also quantify the externalities generated by peer effects, which can amplify the impact of changes in exogenous determinants on leverage by over 70%. MOST RESEARCH ON CORPORATE financial policy assumes that capital structure choices are made independently of the actions or characteristics of their peers. In other words, a firm’s capital structure is typically assumed to be determined as a function of its marginal tax rate, expected deadweight loss in default, information environment, and incentive structure. As such, the role for peer firm behavior in affecting capital structure is often ignored, or at most im