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Production in Entrepreneurial Firms: The Effects of Financial Constraints on Labor and Capital

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  • Mark J. Garmaise
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    Abstract

    I model the contrasting capital-labor decisions of financially constrained and unconstrained firms. I show that financially restricted firms use relatively more labor than physical capital because informed employees provide more efficient financing than uninformed capital suppliers. I demonstrate that constrained firms cannot easily attract new employees to replace existing staff. Their greater employee retention aligns owner-worker incentives and encourages workers to make firm-specific investments. Constrained firms, however, gradually suffer from their inability to replace low-quality workers, such that their relative labor productivity decreases over time. Empirical tests utilizing instrumental variables confirm several implications of the theory. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

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    File URL: http://hdl.handle.net/10.1093/rfs/hhm081
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    Bibliographic Info

    Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

    Volume (Year): 21 (2008)
    Issue (Month): 2 (April)
    Pages: 543-577

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    Handle: RePEc:oup:rfinst:v:21:y:2008:i:2:p:543-577

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    Cited by:
    1. Natasha Agarwal & Chris Milner & Alejandro Riaño, 2013. "Credit Constraints and FDI Spillovers in China," CESifo Working Paper Series 4313, CESifo Group Munich.
    2. Marina-Eliza Spaliara, . "Do Financial Factors Affect The Capital-Labour Ratio: Evidence From UK Firm-Level Data," Discussion Papers 09/04, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    3. Murillo Campello & Erasmo Giambona, 2011. "Capital Structure and the Redeployability of Tangible Assets," Tinbergen Institute Discussion Papers 11-091/2/DSF24, Tinbergen Institute.
    4. Kenichi Ueda & Stijn Claessens, 2008. "Banks and Labor as Stakeholders: Impact on Economic Performance," IMF Working Papers 08/229, International Monetary Fund.
    5. Santiago Carbó Valverde & Francisco Rodríguez-Fernández & Gregory F. Udell, 2008. "Bank lending, financing constraints and SME investment," Working Paper Series WP-08-04, Federal Reserve Bank of Chicago.
    6. Uras, Burak R., 2014. "Corporate financial structure, misallocation and total factor productivity," Journal of Banking & Finance, Elsevier, vol. 39(C), pages 177-191.

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