Financing constraints, irreversibility, and investment dynamics

Abstract

We develop a model of an industry with many heterogeneous firms that face both financing constraints and irreversibility constraints. The financing constraint implies that firms cannot borrow unless the debt is secured by collateral; the irreversibility constraint that they can only sell their fixed capital by selling their business. We use this model to examine the cyclical behavior of aggregate fixed investment, variable capital investment, and output in the presence of persistent idiosyncratic and aggregate shocks. Our model yields three main results. First, the effect of the irreversibility constraint on fixed capital investment is reinforced by the financing constraint. Second, the effect of the financing constraint on variable capital investment is reinforced by the irreversibility constraint. Finally, the interaction between the two constraints is key for explaining why input inventories and material deliveries of US manufacturing firms are so volatile and procyclical, and also why they are highly asymmetrical over the business cycle.JEL classification: D21, E22, E32, G31

Firm Entry and Employment Dynamics in the Great Recession

“…This finding is similar to Caggese (2007) and Khan and Thomas (2010). The intuition is simple: Since the price of debt is less (or equal) to the stochastic discount factor of firms, debt is on average costly and thus firms are better o↵ by paying back their debt.…”

What inventory behavior tells us about how business cycles have changed

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Patents as collateral

“…There remains a ceiling (higher than the interest rate) to the growth rate, because R&D investment should not totally crowd out households consumption, which has to remain positive. 10 Figure 1 below presents a graphical representation of the steady state with the growth rate on the vertical axis and the interest rate on the horizontal axis. Fig.…”

“…Their framework paved the way to new studies of monetary policy and housing prices (Iacoviello (2005) Caggese (2007) and Sveen and Weinke (2007). Lumpiness is also an observed characteristic of R&D investment in lab equipment (Geroski, Van Reenen and Walters (1997), Aghion et al (2007)).…”