When does leverage hurt productivity growth? A firm-level analysis

In the wake of the global financial crisis, several macroeconomic contributions have highlighted the risks of excessive credit expansion. In particular, too much finance can have a negative impact on growth. We examine the microeconomic foundations of this argument, positing a non-monotonic relationship between leverage and firm-level productivitygrowth in the spirit of the trade-off theory of capital structure. A threshold regression model estimated on a sample of Central and Eastern European countries confirms that TFP growth increases with leverage until the latter reaches a critical threshold beyond which leverage lowers TFP growth. This estimate can provide guidance to firms and policy makers on identifying “excessive” leverage. We find similar non-monotonic relationships between leverage and proxies for firm value. Our results are a first step in bridging the gap between the literature on optimal capital structure and the wider macro literature on the finance-growth nexus.