Debt, Collateral, And U.S. Manufacturing Investment: 1954-1980

I perform an empirical analysis of Euler equations for the firm’s choices of capital, labor, hours, and debt. Financial structure has real effects, since taxes favor debt. However, the cost of debt increases with the debt-to-collateral ratio, and capital is part of collateral. The data, for U.S. manufacturing investment from 1954 to 1980, show that the debt-to-collateral ratio moves opposite to the direction suggested by tax rates. However, excluding the Euler equation for debt implies the correct sign for the relation between investment and the debt-to-collateral ratio. I also find structural instability in the Euler equations for debt and capital.