Long-term investment and net-worth building with limited contract enforcement

Research output: Contribution to journalArticleScientificpeer-review

Abstract

This paper develops a firm dynamics model augmented with an endogenous net-worth-building feature at the firm level and investigates how opportunities for entrepreneurs to accumulate wealth can mitigate the implications of limited enforceability for resource allocation, productivity, and macroeconomic development. In the steady-state equilibrium of the model, financially constrained entrepreneurs select short-term investment projects because short-term investment enhances net-worth building and relaxes credit constraints. The limited contract enforceability suppresses macroeconomic output; however, entrepreneurial net-worth building offsets the per capita income losses. I calibrate the steady state of the model for the U.S. economy as a baseline and conduct quantitative exercises. The counterfactual simulations reveal that net-worth building could reduce, for instance, about two-thirds of the per capita income discrepancy between the United States and Brazil that can be attributed to limited enforcement. The theoretical and quantitative results from the paper are highly relevant to financial development and entrepreneurship policies implemented in developing countries.
Original languageEnglish
Pages (from-to)276-312
JournalMacroeconomic Dynamics
Volume20
Issue number1
DOIs
Publication statusPublished - Jan 2016

Keywords

  • Net-Worth Building
  • Limited Enforcement
  • Allocations
  • Total Factor Productivity

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