Misallocation and Credit Market Constraints: the Role of Long-Term

Abstract

We analyze misallocation of capital in a model where firms face different types of financial constraints. Private firms borrow subject to a collateral constraint while public firms issue long-term bonds subject to default risk. We integrate our model with private and public firms into a life-cycle model with idiosyncratic productivity shocks, capital adjustment costs, and firm entry and exit. To estimate our model, we use employment and financial statistics reflecting the overall distribution of firms in conjunction with firm-level data on credit spreads that we target for the set of public firms. In our model, a productive private firm is unable to grow fast if its collateral is limited. But a productive public firm can overcome its financial constraints because it faces low borrowing costs in the debt market, a relationship we also verify in the data. As a result, financial frictions for private firms disrupt investment behavior to a greater degree and generate a larger misallocation of resources relative to financial frictions for public firms.

The Provision of Long-Term Credit and Firm Growth in Developing Countries

“…The maturity linked to long-term financing effectively affects sales, as well as improving the revenue generated from total sales. Empirical papers have pointed out that a firm can gain huge sales and revenue benefits from long-term connections with the same investor (Karabarbounis & Macnamara, 2019). Recent research papers have demonstrated that LTC provides greater flexibility in terms of sales and resources to fund capital demands.…”