44 Pages Posted: 8 Dec 2015 Last revised: 8 Jul 2016
Date Written: June 30, 2016
We ask whether financial assets are well-allocated in the cross-section of firms. Extending the framework of Hsieh and Klenow (2009) to the liabilities side of the balance sheet, we estimate the real losses that accrue from the cross-sectional misallocation of financial liabilities across firms. Using U.S. and Chinese data on manufacturing firms, we find significant misallocation of debt and equity. Although financial liabilities appear well-allocated in the United States, they are not in China. If China's debt and equity markets were as developed as those in the United States, China would realize gains of 40-55% in real firm value. We also back out the cost of debt and equity for each firm with our model, taking into account allocation distortions. We find that larger firms and firms located in more developed cities face markedly lower costs.
Keywords: misallocation, cross-sectional efficiency, capital structure
JEL Classification: G32, O11, O16
Suggested Citation: Suggested Citation
Whited, Toni M. and Zhao, Jake, The Misallocation of Finance (June 30, 2016). Ross School of Business Paper No. 1295. Available at SSRN: https://ssrn.com/abstract=2699817