Firms' leverage, i.e. the ratio between debt and equity (including profits), is usually driven in opposite directions by its two components (up and down respectively). Specifically, leverage could increase during busts because debt grows faster than equity or because a decrease in debt is offset by a larger decline in equity due to losses. This study evaluates how the relative contributions of debt and equity affect leverage across the cycle and whether dynamics differ among size classes.
Aggregate leverage initially increases during busts, as debt growth remains steady while the counterbalancing contribution of equity is smaller; after one year, leverage decreases, as debt slows down. There are differences by firm size: leverage increases more at the beginning of busts for both very large and smaller firms; after one year, leverage decreases less for the latter, mainly due to persistently lower profits.
