Working Paper: NBER ID: w17760
Authors: Raghuram Rajan
Abstract: The nature of the firm and its financing are closely interlinked. To produce significant net present value, an entrepreneur has to transform her enterprise into one that is differentiated from the ordinary. To achieve the control that will allow her to execute this strategy, she needs to have substantial ownership, and thus financing. But it is hard to raise finance against differentiated assets. So an entrepreneur has to commit to undertake a second transformation, standardization, that will make the human capital in the firm, including her own, replaceable, so that outside financiers obtain control rights that will allow them to be repaid. I argue that the availability of a vibrant stock market helps the entrepreneur commit to these two transformations in a way that a debt market would not. This helps explain why the nature of firms and the extent of innovation differ so much in different financing environments.
Keywords: No keywords provided
JEL Codes: G32; L22; L26
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| differentiation (J62) | unique organization (L39) |
| unique organization (L39) | distinctive goods and services (L89) |
| substantial ownership of assets (G32) | control to coordinate with collaborators (E61) |
| differentiation (J62) | financing difficulty (G32) |
| standardization (L15) | replaceable human capital (J24) |
| replaceable human capital (J24) | outside financiers obtain control rights (G34) |
| vibrant stock market (G10) | support for standardization (L15) |
| debt market (H63) | limitations on financing (G32) |
| ownership (H13) | ability to attract financing (G32) |