Contracts, Firm Dynamics and Aggregate Productivity

We construct a framework of firm dynamics to evaluate the impact of the enforcement of contracts between final goods producers and their intermediate goods suppliers on firm life-cycle growth, technology accumulation and aggre-gate productivity. We build upon the tractable contracts model of Acemoglu et al. (2007), where the final goods firm chooses technology in contractible activi- ties conducted by suppliers of intermediate inputs. Suppliers select investments in noncontractible activities, anticipating the pay offs of a bargaining game with the producer of the final goods. We show that contractual incompleteness im-plies a wedge on profits for producers of final goods, potentially dependent on the level of technology of the firm, which disincentives technology accumulation at the firm level in our dynamic model. We evaluate this mechanism in general equilibrium to analyze its quantitative implications. Our model accounts for differences in output per worker of up to 33 percent across economies with complete and incomplete contracts. The impact on firm life-cycle growth, the age and size distribution of firms is quantitatively significant.