Misallocation and Financial Frictions: the Role of Long-Term Financing

Patrick Macnamara and Marios Karabarbounis

No 873, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: This paper analyzes the effect of financial frictions on misallocation when firms can issue long-term bonds and can default on their obligations. Our model combines the endogenous investment, firm-financing structure of Hennessy and Whited (2007) with the long-term financing model of Hatchondo and Martinez (2009). We show that when investment is endogenous and firms issue long-term debt, productive firms can face as severe borrowing constraints as the low productivity firms. This occurs because good firms are more likely to refinance and hence "dilute" their existing debt obligations. A key step of our exercise is that we match the large cross-sectional dispersion in credit spreads we observe in the data. In our model productivity loss due to misallocation is about 10% which is 2.5 times higher compared to a model with short-term financing or exogenous collateral constraints.

Date: 2017
New Economics Papers: this item is included in nep-dge
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Journal Article: Misallocation and Financial Frictions: the Role of Long-Term Financing (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:873

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