Should I Stay or Should I Go: Investor Protection, Firm Selection and Aggregate Productivity

Bernardo Morais
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Bernardo Morais: UCLA

No 878, 2011 Meeting Papers from Society for Economic Dynamics

Abstract: The large cross-country variation in income per capita and aggregate productivity is highly correlated with various measures of investor protection. To account for this pattern I propose a theory of aggregate productivity based on firm selection. According to this theory, improvements in investor protection reduce the cost of credit of young firms, increasing the value of starting a project anew. This increase in the outside option of an incumbent raises the exit rate of low quality firms. A consequence of this selection mechanism is that the average productivity of old firms relative to young ones is increasing in the quality of investor protection. Using a comprehensive cross-country panel of firms, I show that this prediction holds in the data. What is more, quantitative simulations indicate that this selection mechanism accounts for around 25 percent of the cross-country differences in aggregate productivity. The model provides additional testable predictions reenforcing the plausibility of the theory. I show that in countries with better investor protection there is a larger share of young firms, these firms start larger, grow more slowly and deleverage more quickly. Finally, I analyze the effect that an exclusion from credit markets for an insolvent debtor has on the cost of credit and on aggregate outcomes. I find that the length of the exclusion that maximizes income per capita, is decreasing in the quality of investor protection.

Date: 2011
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed011:878

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