Essays on Firm Dynamics Under Financial Frictions

Abstract

This dissertation consists of two essays that examine how financial frictions affect firm dynamics. The first essay studies how pervasive patterns in firms' financing dynamics – that is, raising financing (i) infrequently in a lumpy fashion, and (ii) before running out of cheaper internal funds – may arise from the presence of financiers' bargaining power. It shows that, contrary to the common intuition but consistent with empirical patterns, firms with poor access to financing raise external financing highly infrequently and after having exhausted most of their internal funds, whereas firms with great access to financing raise external financing frequently and well before exhausting internal funds.The second essay shows that financial frictions may have stark distributional implications on startup firms' innovation activity. If startups expect to face financial frictions when making investment following a successful innovation, there are increasing returns to scale in startup funding. Consequently, innovation is endogenously concentrated towards startup firms that initially possess a sizable internal funds and choose to raise even more external financing for innovation. In short, innovation is concentrated due to the asset distribution of potential entrepreneurs.Overall, this dissertation illuminates two novel theoretical channels – bargaining and stages of investment – through which financing affects firm dynamics.