Firm Dynamics and Growth with Soft Budget Constraints

Philippe Aghion, Antonin Bergeaud, Mathias Dewatripont and Johannes Matt

No 19996, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study how financial conditions shape firm dynamics and economic growth. We develop a Schumpeterian growth model in which limited commitment in debt markets gives rise to a soft budget constraint syndrome. Because financiers cannot commit not to refinance underperforming innovators, funding may be misallocated. Tighter financial conditions reallocate resources toward entry but reduce incumbent innovation, generating a hump-shaped relationship between refinancing costs and growth. We characterize the optimal refinancing policy and show that it depends critically on the elasticity of entry. Calibrating the model to French firm-level data, we find that the optimal response to a refinancing cost shock is to ease refinancing conditions, preserving incumbent innovation at the expense of lower entry and substantially mitigating the resulting growth and welfare losses.

Keywords: Firm; dynamics (search for similar items in EconPapers)
JEL-codes: E44 E50 O30 O43 (search for similar items in EconPapers)
Date: 2025-03
New Economics Papers: this item is included in nep-sbm
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