I study how product market strategy influences corporate investment and financing policy. Using data on firms' product portfolio structure, I show that product portfolio age is negatively related to firm value, investment and leverage, consistent with the product life cycle channel. An estimated dynamic model of firms' financing, investment, and product portfolio decisions shows that the negative relationships exist because capital investment and product introductions act as complements, leading to a stronger precautionary savings motive when the firm's product portfolio ages. The structural estimates imply large effects of the product life cycle channel, with firms acting as if new products were twice as profitable as old ones, and document that firms are more exposed to product-level economic forces when they supply fewer products and compete more intensely. Counterfactual analysis implies that alleviating product life cycle effects can increase firm value by up to 3.5%.
Recent empirical studies show that innovative firms heavily rely on debt financing. This paper develops a Schumpeterian growth model in which firms' dynamic R&D, investment, and financing choices are jointly and endogenously determined. It then investigates the relation between debt financing and innovation and growth. The paper features a rich interaction between firm policies and predicts substantial intra-industry variation in leverage and innovation, consistent with the empirical evidence. It also demonstrates that while debt hampers innovation by incumbents due to debt overhang, it also stimulates entry, thereby fostering innovation and growth at the aggregate level.
I develop a dynamic capital structure model to examine how the nature of risk affects debt policy. In the model, the firm's fundamental risk, captured by its cash flow process, consists of transitory and persistent parts with markedly different dynamics. The model explains the observed dispersion in the risk-leverage relationship. Firms with similar total volatility adopt distinctive debt policies when the composition of their risk differs and issue less debt when their cash flows are more persistent to preserve debt capacity needed to fund investment. The model also provides rationale why the observable dispersion in cash flow persistence is low, which is at odds with the large degree of heterogeneity in other firm characteristics, as well as why persistence and leverage are weakly related in the data.