We examine how product life cycle affects investment and financing by estimating an industry equilibrium model that embeds product portfolio characteristics. In the model, firms trade off higher profitability of newer products versus product introduction costs. Using product-level data, we find that the product dimension is critical in quantitatively explaining cash flow dynamics, corporate policies, and industry structure. We show that product introductions and capital investment are complements and that product dynamics incentivize preserving more debt capacity. Our estimates reveal that product life cycle is more pronounced for firms with smaller and more concentrated product portfolios as well as those with high product variety.

Recent empirical studies have shown that innovative firms heavily rely on debt financing. Debt overhang implies that debt hampers innovation by incumbents. A second effect of debt is that it stimulates innovation by entrants. Using a Schumpeterian growth model with endogenous R&D and financing choices, we demonstrate that this second effect always dominates, so that debt fosters innovation and growth at the aggregate level. Our analysis suggests that the relation between debt and investment is more complex than previously acknowledged and highlights potential limitations of empirical work that solely focuses on incumbents when measuring the effects of debt on investment.

Capital ages and must eventually be replaced. We propose a theory of financing in which firms borrow to finance investment and deleverage as capital ages to have enough financial slack to finance replacement investments. To achieve these dynamics, firms issue debt with a maturity that matches the useful life of assets and a repayment schedule that reflects the need to free up debt capacity as capital ages. In the model, leverage and debt maturity are negatively related to capital age while debt maturity and the length of debt cycles are positively related to asset life. We provide empirical evidence that strongly supports these predictions.