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Costly External Finance and Investment Efficiency in a Market Equilibrium Model

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  • Jan Zabojnik

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Abstract

The corporate finance literature suggests that a financially constrained firm invests less than an identical unconstrained firm. This does not imply that financial frictions cause firms to invest less than they would in a frictionless economy. When firms compete for investment funds, an increase in financial frictions can lead individual firms to increase their investment levels. A greater than the frictionless level of investment is likely in low productivity firms, in cash-rich firms, and in firms with cheap external capital. Government programs that make capital cheaper for small firms may lead to lower levels of investment for all firms and decrease efficiency.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1160.pdf
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1160.

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Length: 32 pages
Date of creation: Mar 2008
Date of revision:
Publication status: Forthcoming in Economic Inquiry
Handle: RePEc:qed:wpaper:1160

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Keywords: Financial Frictions; Investment distortions;

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