Firm Leverage and Wealth Inequality

This paper studies the effects of a change in firm leverage on wealth inequality and macroeconomic
aggregates. The question is studied in a general equilibrium model with a continuum of heterogeneous
agents, life-cycle, incomplete markets, and idiosyncratic and aggregate risk. The analysis focuses on the
particular change in firm leverage that occurred in the U.S. during the 1980s, when firm leverage increased
significantly, and subsequently has been dropping since the early 1990s. In the benchmark model, an
increase in firm leverage of the size that occurred during the 1980s increases capital accumulation by
5.38 %, decreases wealth inequality by 1.07 Gini points and decreases government revenues by 0.11 %
of output. Consequently, the model implies that the increase in firm leverage did not contribute to rising
inequality in the U.S. in the 1980s, but rather the opposite; that the reduction in leverage from the early
1990s to 2008 has contributed to rising wealth inequality. Furthermore, I show that if the model abstracts
from beneficial tax treatment of corporate debt, the change in leverage has only minor effects on macro
aggregates and inequality, despite having significant implications for asset prices. This is consistent with
the previous result in the literature showing that the Modigliani-Miller theorem approximately holds in
the heterogeneous agents model with imperfect markets.