Corporate Finance and the Transmission of Shocks to the Real Economy
The transmission of credit supply or monetary policy shocks to the economy depends on frictions in different credit markets. For example, the degree to which a policy rate change affects firms’ funding costs depends on the substitutability of bond and bank financing as well as the substitutability of loans across different banks. Additionally, idiosyncratic productivity shocks may have an aggregate impact, depending on how firms can leverage up investment in more productive capital. This paper introduces a theoretical framework to study firms’ corporate finance choices and their implications for the transmission of shocks to the real economy. The model allows a firm to choose between self-financing or external debt funding through the bond market or bank loans.