RFS Advance Access originally published online on December 13, 2007
Review of Financial Studies 2008 21(2):543-577; doi:10.1093/rfs/hhm081
| ||||||||||||||||||||||||||||||||||||||||||||||||||
Production in Entrepreneurial Firms: The Effects of Financial Constraints on Labor and Capital
UCLA Anderson
Address correspondence to Mark Garmaise, UCLA Anderson, 110 Westwood Plaza, Los Angeles, CA 90095, USA: telephone: (310) 794-4118: e-mail: mark.garmaise{at}anderson.ucla.edu.
JEL Classification: G32, L26
 |
Abstract |
|---|
I model the contrasting capital-labor decisions of financially constrained and unconstrained firms. I show that financially restricted firms use relatively more labor than physical capital because informed employees provide more efficient financing than uninformed capital suppliers. I demonstrate that constrained firms cannot easily attract new employees to replace existing staff. Their greater employee retention aligns owner-worker incentives and encourages workers to make firm-specific investments. Constrained firms, however, gradually suffer from their inability to replace low-quality workers, such that their relative labor productivity decreases over time. Empirical tests utilizing instrumental variables confirm several implications of the theory.
I have benefited from the suggestions and comments of Tony Bernardo, Matthias Kahl, Kjell Nyborg, Robert L. McDonald (the editor), an anonymous referee, and seminar participants at the University of Southern California, Tel Aviv University, and Hebrew University. I gratefully acknowledge the support of the Harold and Pauline Price Center for Entrepreneurial Studies at UCLA.