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.

According to data from Compustat, we observe three general trends between 1980 and 2012. First, firms have been reducing their reliance on debt, as leverage ratios have fallen and an increasing fraction of firms are now actually net lenders. Second, the frequency at which firms neither issue external equity nor distribute dividends to shareholders has fallen. Third, marginal corporate income tax rates have fallen significantly as well. Using Compustat balance sheet data, we structurally estimate a model in which heterogeneous firms finance investment with equity and debt. Our model incorporates costly external finance as well as a detailed tax structure, including personal, dividend and corporate income taxes. We conclude that there has been a significant reduction in the cost of external equity, while overall leverage ratios have fallen mainly because of a lower tax advantage of debt.

This paper considers a model of firm dynamics to study how well aggregate shocks account for fluctuations in the entry and exit of establishments. To do this, I construct measures of aggregate technology, labor and investment shocks. Under reasonable parameters, the model indicates that labor shocks (and not technology or investment shocks) best account for cyclical fluctuations in entry and exit rates. Moreover, this has had significant implications for the aggregate economy, as entry and exit have made output and hours more volatile and persistent.

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 integrate our model with private and public firms into a life-cycle model with idiosyncratic productivity shocks, capital adjustment costs, and firm entry and exit. To estimate our model, we use 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.

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