Firm Financing over the Business Cycle

We study the investment and nancing policies of public U.S. rms. Large rms substitute between debtand equity nancing over the business cycle whereas small rms' nancing policy for debt and equity is pro-cyclical. This paper proposes a novel mechanism that explains these cyclical patterns in a quantitative heterogeneous rm industry model with endogenous rm dynamics. We nd that cross-sectional di erences in investment policies and therefore funding needs as well as exposure to nancial frictions are key to understand how rms' nancing policies respond to macroeconomic shocks. Financial frictions cause rms to be larger with lower valuations and less investments.