The Growth Opportunity Channel of Debt Structure

This paper studies the importance of growth opportunities for debt structure decisions. High growth firms use more unsecured debt to preserve financial flexibility (in the form of untapped secured debt capacity) in connection with future growth opportunities: the growth opportunity channel of debt structure. Our base regression results establish a strong positive relation between growth opportunities and unsecured debt. To better identify this relation, we examine the effects of the Biologics Price Competition and Innovation Act (BPCIA) of 2010 on the debt structure of the pharmaceutical industry. We show that pharmaceutical firms responded to the positive BPCIA-induced growth shock by shifting their debt structures towards more unsecured debt. Our large sample tests indicate that although unsecured debt has a direct negative effect on leverage, that effect is strongly mitigated for high growth firms. High growth firms may attract more unsecured funds because their greater growth opportunities are more likely to generate cash flows in excess of secured debt repayments. Our posited growth opportunity channel of debt structure is complementary to, but conceptually distinct from, more classic explanations of debt structure based on collateral and adverse selection