Financial Frictions, Equity Constraints, and Average Firm Size Across Countries

We document new evidence that low equity in financially under-developed economies is associated with lower productivity investment, a smaller employment share of large firms, and smaller average firm size within sectors. We present a tractable model with heterogeneous entrepreneurs that face equity constraints that limit investment at entry. The model can be solved analytically, making clear predictions for the impact of equity constraints on outcomes of interest consistent with the evidence we document. The model can account for one-fifth to one-third of the variance in observed average firm size and TFP across countries, all substantial relative to the literature.