Finance, Organization and Misallocation
Speaker: Prof. Xiaodong Zhu (University of Toronto)
We study financial frictions and limits to delegation in a model with endogenous hierarchies. We show that due to endogenous span of control, financial frictions have a much more persistent effect on capital misallocation than a standard Lucas span of control model commonly used in the misallocation literature. We also study managerial contracting frictions in this framework. Weak contract enforcement prevents productive firms from hiring outside managers and increasing their span of control. While the financial friction generates capital wedges mainly for smaller firms with insufficient collateral, the managerial contract friction generates output wedges that increase with firm size. We jointly quantify the impact of these two frictions on aggregate productivity using micro data from China. We find that, in the Chinese context, eliminating these two frictions can increase labor productivity by up to 16%. About half of the increase is from eliminating the managerial friction.