Misallocation and financial frictions: The role of long-term financing

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 estimate our model using 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. (C) 2020 Elsevier Inc. All rights reserved.

Automated summary

The model suggests that due to financial frictions leading to misallocation of capital, private firms face greater difficulties in achieving rapid growth compared to public firms.