How severe are financial constraints over the early life cycle of firms? We know that young firms in less developed economies operate in environments with worse contract enforcement and have lower (higher) levels of long-term (short-term) leverage. Traditional models of endogenous borrowing constraints are inadequate to capture these facts because i) they typically generate higher levels of long leverage in less developed economies, and ii) they do not pin down the short and long composition of total leverage. This paper proposes a model of endogenous borrowing constraints that solves i) by introducing endogenous (target) scale choice of firms and solves ii) by introducing transaction costs. The main implication of the model is that short-term funding gaps are biased measures of the severity of financial constraints. This bias emerges due to the initial unobservable scale distortion. The model provides a set of moments to infer the unobservable distortion using cross-country data allowing us to construct a measure of the severity of financial constraints. Moreover, the model generates testable implications of short- and long-leverage dynamics. Specifically, constrained young firms will increase their short-leverage and decrease long-leverage as they age. The paper shows these patterns in a sample of European private firms and applies the proposed methodology to study the severity of financial constraints for the average young firm in European countries with relatively low and high enforcement.
Cross Country Patterns of Relative Misallocation in Services and Manufacturing: Theory and Evidence.
While we have some evidence that misallocation is higher in services than in manufacturing, these findings have been produced in the context of intra-country comparison. Is misallocation consistently higher in the service sector? Is there a pattern of the severity of misallocation in the service sector? I answer the later question by presenting a novel fact: misallocation in the service sector is relatively more severe at lower levels of development. To rationalize the previous fact, I present a model of industry dynamics, endogenous borrowing constraints, and financial structure. I use the model to quantify the TFP losses implied by the patterns of premature deindustrialization.
Ex-Post Efficient Risk Sharing with Private Information and Limited Commitment. (with Nicolas Caramp)
Sovereigns might find that state-contingent bonds have attractive risk-sharing properties, however the fact that the national authorities are reporting the states limits the implementable risk-sharing arrangements. For example, Argentina issued state-contingent bonds (bonds whose payments were tied to GDP or inflation) and then misreported inflation. In this sense, the natural environment to study the design of state-contingent bonds is an economy with private information and limited commitment. The literature has characterized the optimal contract in this setting. A common feature of the resulting contract is that it is ex-post inefficient (i.e., there exists another contract that generates an ex-post Pareto improvement). In this paper we propose a notion of limited commitment involving renegotiation proofness. To capture the idea that mutually beneficial trades should occur between parties constantly interacting in markets, we solve the optimal contract under asymmetric information, limited commitment of the agent, and limited commitment of the principal. Specifically, we assume that the principal cannot commit not to renegotiate. While this breaks the traditional revelation principle, we show how to implement the general version of the revelation principle under limited commitment in our setting. We propose a decentralization a la Alvarez Jerman (2000) and study the role of constraints coming from limited enforcement and adverse selection.
Work in Progress
Rank Reversals of Financial Constraints, Revisiting Financial Dependence Measures.
Industrial Composition and Country Risk Profiles.
Endogenous Borrowing Constraints and The Life Cycle of Plants.
A Theory of Productivity in Services and Manufacturing.