Leverage, liquidity, and investment: The cyclical effects of corporate debt

How does corporate debt shape firms’ investment behavior across the business cycle? Using firm level balance sheet data for Spanish companies over 1997–2019, we estimate a flexible panel data model and a doubly robust difference in differences design to identify the causal effect of leverage on investment. We find that leverage stimulates investment before 2008 but strongly contracts it during the post-2008 deleveraging period. After 2008, highly indebted firms reduce their investment rate by 1.8 percentage points more than less indebted firms. This contraction is concentrated among small and medium sized enterprises, with micro firms cutting their investment rate by 6.3 percentage points and firms in construction showing particularly strong declines. In contrast, investment by large firms remains comparatively stable. The results underscore the procyclical nature of corporate debt and suggest the importance of closely monitoring firm leverage and liquidity conditions, particularly for SMEs, during periods of economic expansion and contraction. • We ask whether debt raises investment in booms but depress in recessions. • We analyze Spanish firms from 1997 to 2019 using TWFE and doubly robust DiD. • Before 2008, SME debt raises investment; after 2008, the relation turns negative. • After 2008, DiD shows high-debt firms cut investment 1.8 pp, 6.3 pp for micro firms. • Construction has the largest post-2008 investment drop for high-debt firms.