Government debt and corporate leverage: exploring beyond the crowding-out effect and the impact of COVID-19

Purpose This study aims to investigate the impact of government debt on corporate financing decisions in low- and lower-middle-income countries, focusing on unexplored channels through which government debt influences these decisions. Design/methodology/approach This study uses a regression model to investigate the impact of government debt on corporate leverage. This study regresses corporate leverage on government debt, as well as other control variables that the literature identifies as potential determinants of corporate leverage. The regression model also includes firm and time fixed effects to control for unobserved firm and time effects. This study also uses an instrumental variable approach to address endogeneity concerns. Findings This study provides novel empirical evidence of a positive relation between government debt and corporate leverage in low- and lower-middle-income economies, where the conventional crowding-out effect is not only weaker but also dominated by alternative channels. Furthermore, this study documents that both external and domestic government debt are associated with higher corporate leverage. This study also examines the financing and opportunity channels, revealing that this positive relationship is stronger among firms with greater growth opportunities and those experiencing more financial constraints. In addition, this study finds that the positive effect of government debt on corporate leverage is less pronounced during the COVID-19 period. Originality/value First, this study provides evidence of a crowding-in effect of government debt on corporate leverage across low-income economies, a setting that has received limited attention in prior research. Second, the findings complement and build upon emerging evidence of crowding-in effects in developing regions. Third, this study offers new empirical evidence on the mechanisms behind the crowding-in effect, including opportunity and financing channels. Finally, this study contributes to the growing literature on government debt and crisis-period financing by showing that the positive effects of government debt on corporate leverage weaken during the COVID-19 pandemic.