The Credit Sentiment Effect: An analysis of behavioral credit cycles on capital structure

Imperfect capital markets are more oftenidentifiedto affect firm’s decision making. To further analyze the influence of supply side factors of the credit market on firm’s capital structure, this paper describes, with the use of aformulation of behavioral credit cycles,a panel data analysis of leverage ratios and net debt issues ofUS non-financial businesses between 1987 and 2018.Resultsindicatethe presence of a credit sentiment effect on bothcapital structure measures, although accounting for only a small part of the variation. An increase in the credit sentiment index,specifically the difference in probability to default of firms issuing a highcompared to alowlevelof debt, is therefore associated with an increase in leverage and debt issuance. Furthermore, findings suggesta higher credit sentiment effect on long-term debt and on net debt issues for firms facing higher financial constraints. No significant reversal of the initial increase in leverage and debt issuance was found in the following two to three years.