Firm-level Uncertainty and Productivity: the Financial Friction Channel
47 Pages Posted: 20 Jul 2020 Last revised: 22 Nov 2023
Date Written: November 17, 2023
Abstract
This paper studies how firm-level uncertainty affects productivity. Empirically, we find that productivity accounts for approximately 68% of the negative impacts of uncertainty on output, while the reduction in physical capital investment accounts for only 3%. We interpret this finding using a dynamic model with endogenous productivity and defaultable debt. Uncertainty has little impact on the expected level of cash flows but increases the default probability and hence tightens the borrowing limit. When faced with uncertainty shocks, firms have strong incentives to replace productivity-enhancing efforts with physical capital accumulation, as the latter is crucial for corporate liquidation value and debt price. Our paper demonstrates that firms respond differently to second-moment uncertainty shocks compared to first-moment productivity shocks.
Keywords: Firm-level Risk; Total Factor Productivity; Financial Friction; Defaultable Debt; Human Capital
JEL Classification: D24, D81, G32, J24, O47
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