We investigate the impact of government debt on corporate financing decisions. We document a negative relation between government debt and corporate leverage using data on 40 countries between 1990 and 2014. This negative relation holds only for government debt that is financed domestically and is stronger for larger and more profitable firms and in countries with more developed equity markets. In order to address potential endogeneity concerns, we use an instrumental variable approach based on military spending and a quasi-natural experiment based on the introduction of the Euro currency. Our findings suggest that government debt crowds out corporate debt.
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