Leverage Dynamics in Product-Market Networks

Abstract

We examine whether corporate leverage persistence reflects only firms' own adjustment frictions or also the past financing choices of economically connected firms. We combine annual firm fundamentals with time-varying text-based product-market networks and estimate a heterogeneous dynamic partial-adjustment model with interactive effects using defactored instrumental variables. The estimator accommodates time- varying network weights and spatial dependence in firm-specific coefficients. Network-weighted lagged leverage is positive and statistically significant, with a mean coefficient representing approximately 45% of the sum of the own and network lag coefficients for book leverage. Accounting for network dependence reduces the persistence attributed to firms' own financing histories and increases the implied own-firm speed of adjustment. Firm-specific estimates reveal significant product-market clustering in own-leverage persistence and in responses to several leverage determinants, showing that heterogeneity in financing behaviour is systematically related to product-market proximity. The evolution of product-market connections matters quantitatively for network dependence: holding the network fixed produces a substantially larger network coefficient and considerably larger indirect effects than using annual network weights. Network dependence is therefore an economically important component of leverage dynamics, while its measurement depends on both the specification of economic connections and heterogeneity in firm behaviour.