Leverage Risk and Investment: The Case of Gold Clauses in the 1930s
AbstractWe study the impact of the 1933 abrogation of gold clauses on the slow recovery of corporate
investment following the Great Depression. Legal challenges to the constitutionality of the
abrogation of gold clauses exposed many firms to the possibility of a 69% increase in required
payments to bondholders. We show that public firms with higher exposure to this risk
reduced their investment in 1933 and 1934. For these firms, investment recovers quickly
following the Supreme Court’s 1935 decision to uphold abrogating gold clauses. In the cross-section
of firms, decreases in investment over 1933 and 1934 coincide with an increase in
equity payouts. Our estimates imply that the risk of higher financial leverage accounts for
about one-third of the decline in aggregate investment by public firms over 1933 and 1934.
This channel complements existing explanations of the slow recovery based on bank credit
supply which public firms did not rely on.