This study examines the relationship between firm productivity and financial leverage and whether public debt overhang and the composition of government spending shape that relationship. Design/methodology/approach Using a panel of 2,082 listed non-financial firms from 12 EU countries over 2013-2023, we estimate a dynamic partial-adjustment capital-structure model employing system GMM. We test the moderating role of public debt overhang and compare high-and low-spending regimes in education, public R&D, transport infrastructure, the judiciary, and selected non-supply-side expenditures. Findings Firm productivity is positively associated with financial leverage. Public debt overhang is linked to lower leverage and weakens the productivity-leverage relationship […]