Abstract: We model the interaction of financial constraints, capacity constraints, and the response of production and inventory to cost and demand shocks. The model predicts that in response to favourable shocks, financially constrained firms are unable to build up inventory as rapidly as unconstrained firms.  However, because the favourable shocks gradually ease the financial constraints, constrained firms continue to build inventory and eventually carry surplus inventory (relative to unconstrained firms) to unfavourable states. This allows them to deplete inventory more aggressively in response to unfavourable shocks. Our empirical evidence provides broad support for the model's predictions.

Abstract: Many US corporate bonds are callable at a predetermined, fixed price. Callability gives firms the ability to re-price their bonds ex-post. It is less clear how it resolves ex-ante contracting frictions. We show empirically that longer maturity and lower credit quality bonds are frequently issued with callable features. These bonds are often called when issuers experience improvements in credit quality. Firms with callable debt are more likely to increase investment following positive industry shocks. Such firms are also more likely to become takeover targets, confirming the prediction of a simple model we construct of debt overhang. The empirical patterns we report fit the theory that call features limit debt overhang by restricting value gains to corporate creditors.