The Misallocation of Finance

44 Pages Posted: 8 Dec 2015 Last revised: 8 Jul 2016

Toni M. Whited

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research

Jake Zhao

Peking University - HSBC Business School

Date Written: June 30, 2016

Abstract

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

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

Toni M. Whited (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jake Zhao

Peking University - HSBC Business School ( email )

University Town
Shenzhen, 518055
China

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