Investors increasingly allocate capital outside of public equity markets and through private equity investments. We evaluate capital allocation efficiency in public and private markets by comparing the marginal product of capital in firms that receive equity in each market. We find that public markets allocate capital more efficiently than private markets. A dollar of equity allocated through public markets generates at least three times more sales than a dollar allocated to comparable firms in private markets. The difference in allocation efficiency is persistent over time and across industries. We use cross-sectional tests and quasi-natural experiments to show that the allocation efficiency gap is driven by improved information efficiency and governance mechanisms in public markets. Our study highlights the role of stock markets in improving capital allocation in the economy, and a potential implication of shrinking public markets and the growth of private equity.

Despite extensive efforts, the impact of the tax benefits of debt on firm decisions is an open question. The 2017 US tax reform creates an opportunity to directly estimate the effects. The reform limits the tax advantage of debt for all firms except for small businesses with average sales below $25 million. I use the exception threshold in a regression discontinuity design and show that corporate debt declines nearly dollar for dollar as the present value of the tax benefits of debt shrinks, but equity financing is not affected. Treated firms decrease their investments and hiring, consistent with the rise in the cost of external financing. The effects are similar in public and private companies. Although the new law disproportionately reduces the tax benefits of debt in small firms, the evidence suggest that the estimates likely provide a lower bound for the effects in large companies. Overall, I document a first-order role for tax incentives that affect the cost of capital in shaping corporate financial and real policies.

Using state-level shocks to workers’ mobility across firms, I show that an increase in labor mobility is related to a decrease in firms use of debt and investment rates. The effects are concentrated in firms that rely on high-skill workers. I develop a dynamic model that provides an economic mechanism to rationalize these findings. In the model, firms make investment and financing decisions, hire labor with different levels of skill and mobility, and set wages through bargaining. Skilled workers with high mobility receive high-value outside job offers more frequently. Firms that rely on this type of labor operate with low leverage in anticipation of the outside offer shocks, to increase financial flexibility that helps them retain their workforce against those shocks. The differences in investment are generated both by the capital-labor complementarity and by the differences in financing policies, which affect the cost of capital. I estimate the model to quantify the effects of changes in workers’ mobility, for example, because of new government policies or the rise of remote work. Counterfactual analyses show that such changes in workers’ mobility have a sizable impact on financing, investment, hiring, and wages in high-skill firms, but little effect on low-skill firms.

Tests using American data from 1970 to 2015 support the behavioral hypothesis that firms Cater to investor whims. We show that the standard tests cannot distinguish between the behavioral interpretation, and a rational model in which the firm optimally chooses investment, equity issuance, and dividends; while investors optimally choose consumption, equity, and bank account deposits. The rational model shows the importance of two-way financial flows between investors and firms that are generally ignored in the literature. Using booms, sentiment, and behavioral mispricing measures, we construct new tests of behavioral Catering Theory. In all cases that theory is rejected.