Firm Entry and Financial Shocks

Abstract

This article shows that firm entry dynamics are an important part of the propagation of financial shocks to the real macroeconomy. A VAR documents empirically that adverse financial shocks are associated with significant declines in both new firm creation and equity values. A DSGE business cycle model combining endogenous firm entry and financial frictions, where firms have a choice of financing entry through debt or equity, can explain these facts. The model implies that adjustment in firm numbers can moderate the impact of financial shocks on aggregate output, as it buffers the equity value and financial stance of surviving firms.

Entry Costs and the Macroeconomy

“…Our assumption of convex entry costs slows entry during booms, which helps match the volatility of entry rates and their relationship to asset prices. This convexity can have multiple interpretations, from diminishing quality in managerial ability (Bergin et al, 2017) to congestion effects at firm creation (Jaef and Lopez, 2014) -perhaps due to a limited supply of Venture Capital needed to finance and monitor entrants (Loualiche, 2016). The entry cost κ j,t is subject to industry-specific and aggregate shocks:…”

Financial Frictions and Trade Dynamics

“…The strategy for identification of the financial shock closely follows that in Bergin et al (2016). The interbank lending rate is used as a measure of tightness of financial conditions over time as in Chor and Manova (2012), as it is a broad measure of financial liquidity in the economy.…”

Financial Frictions and Trade Dynamics

“…The strategy for identification of the financial shock closely follows that in Bergin et al (2016). The interbank lending rate is used as a measure of tightness of financial conditions over time as in Chor and Manova (2012), as it is a broad measure of financial liquidity in the economy.…”

“…However, Bergin et al (2016) shows in a closed economy model that a shock to short term working capital costs can have strong indirect implications for the financing of firm sunk entry costs through endogenous changes in firm capital structure. This paper will develop a two-country dynamic stochastic general equilibrium (DSGE) model with endogenous capital structure to study how a financial shock can lead to both a large temporary fall in trade volume and a drop in extensive margin of trade that has long-lasting effects on trade volume.…”

“…The first is that shocks to costs of financing working capital lead firms to alter their capital structure from debt to more expensive equity financing. Evidence for such capital restructuring during the financial crisis has been provided by Jermann and Quadrini (2012), and Bergin et al (2016) has shown it has important implications for firm entry. An adverse financial shock takes the usual form of a tightening of the collateral constraint for borrowing working capital during a period, which reduces the scale of firm production.…”