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.