Credit Cycles, Expectations, and Corporate Investment

We study the real effects of credit market sentiment on corporate investment and financing for a comprehensive panel of U.S. public and private firms over 1963-2016. In the short term, we find that high credit market sentiment in year t correlates with high corporate investment and debt issuance in year t+1, particularly for financially constrained firms. In the longer term, high credit market sentiment in year t correlates with a decline in debt issuance in years t+3 and t+4; and with a decline in corporate investment in years t + 4 and t + 5. This pattern of increased investment in the short term and declined investment in the longer term is more pronounced for firms with larger analysts' earnings forecast revisions and comes with larger analysts' forecast errors, supporting theories of over-extrapolation of fundamentals into the future. A parsimonious dynamic model where over-extrapolation is the only departure from standard Q-theory does a good job matching the empirical moments of our data