Nicolas Crouzet

Crouzet, Nicolas. 2014. Firm investment and the composition of debt.

I propose a static model of the joint determination of debt structure and the scale of investment. An entrepreneur finances a project of variable size using internal funds and external borrowing from two types of creditors: banks and public debt markets. The key distinction between the two is that, when liquidation looms, bank loans are easier to restructure than market debt. Absent deadweight losses in liquidation, debt structure is irrelevant to the investment choices of the entrepreneur, and projects are financed by whichever lender has the lowest marginal lending cost. With liquidation losses, I show that investment is financed by a combination of bank and market finance so long as 1) banks have higher marginal lending costs than markets and 2) entrepreneurs' internal resources are sufficiently small. In that case, the share of bank finance in total investment depends non-monotonically on internal resources: firms with very limited internal resources are increasingly reliant on bank finance to expand investment, while medium-sized firms reduce the contribution of bank finance for each additional marginal unit of equity. I show that, as a result of firms adopting mixed debt structures, asymmetric changes in lending costs lead to large changes in investment at the firm level.