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Capital misallocation and financial market frictions: Empirical evidence from equity cost of capital

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  • Shen, Junyan

Abstract

This paper quantifies the impact of capital misallocation on the loss in total factor productivity (TFP), arising from financial frictions. A two-period model is built to map the dispersion in the cross-sectional borrowing costs into the TFP loss. Equity cost of capital, which closely relates to the expected profitability, is the main measure of borrowing costs. For the manufacturing sector in U.S., such productivity loss ranges from 3.7 to 9.5 percent. The TFP loss is stronger when credit is tightening and among firms with larger financial constraints. I also explain why Hsieh and Klenow (2009) may overstate the impact of capital misallocation.

Suggested Citation

  • Shen, Junyan, 2023. "Capital misallocation and financial market frictions: Empirical evidence from equity cost of capital," International Review of Economics & Finance, Elsevier, vol. 87(C), pages 486-504.
    • Handle: RePEc:eee:reveco:v:87:y:2023:i:c:p:486-504
    DOI: 10.1016/j.iref.2023.04.012
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    More about this item

    Keywords

    Misallocation; Aggregate TFP; Financial frictions; Cost of capital;
    All these keywords.

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • O47 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence

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