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Financial Aspects of Business Cycles: An Analysis of Balance Sheet Adjustments of U.S. Nonfinancial Enterprises over the Twentieth Century



  • I would like to thank the editor, Masao Ogaki, and four anonymous referees for their patience and helpful suggestions that improved this paper. I would also like to thank Henri Pages, Natacha Valla, Hubert Kempf, Charles Thompson, Gerard Charreaux, James Johannes, and the seminar participants at the Banque de France and the Universite de Bourgogne for many helpful comments, and Lynne Krainer for help in the preparation of this manuscript. This research project was funded by the Fondation Banque de France while the author was a visiting scholar at the Monetary Policy Section of the Banque de France. He would like to thank Henri Pages, Secretary of the Fondation; Christian Pfister, Director of Research; and Laurent Clerc, Head of the Monetary Policy Section for the opportunity to carry out this research at the Banque de France. The views expressed in this paper are not necessarily those of the Banque de France or of the individuals mentioned above.


This paper formulates and tests a model of asset and financing adjustments of nonfinancial enterprises over the twentieth century. Asset adjustments change the expected income and operating risk of firms while financing adjustments change financial risk. To protect debt and equity investors from a conflict of interest problem, an up-front contract develops an “assignment” rule for managing the firm's balance sheet whereby managers make investment decisions that conform to the risk aversion of stockholders and financing decisions that offset changes in operating risk resulting from investment decisions. Empirical evidence gathered in this paper fails to reject the predictions of the model.