Finance Over the Life Cycle of Firms

This paper documents significant differences in firms’ use of debt and equity financing over their life cycles and across countries at different stages of development. I interpret this evidence using a model with learning and financial frictions, in which younger firms rely more on external financing while facing greater uncertainty and risk. The model predicts sizable aggregate losses from financial frictions, larger in less developed countries. Unlike previous work, I find that most of the TFP losses arise from distortions in firms’ exit decisions, reflecting that young firms exit prematurely as external financing costs exceed the option value of learning.