Abstract
We study the relationship between net debt, measured as short-term current liabilities net of cash assets, and income among U.S. corporations. On Compustat firm-level data, we find that operating income rises with net debt quantiles over the range where net debt remains negative, but declines at about the point where net debt becomes positive. We consider a dynamic quantitative partial-equilibrium heterogeneous-firms model with trade credit calibrated to U.S. aggregates. In the model’s cross-sectional distribution of firms, operating income rises with net debt quantiles while net debt is negative, and falls at the point where net debt turns positive. Thus the model accounts for the pattern observed in the data. The drop in operating income near the zero-debt level reflects the concentration of delinquent firms there which comes about because of the insurance role of trade credit default.