Working Paper: NBER ID: w19946
Authors: Konstantin Milbradt; Martin Oehmke
Abstract: Financing terms and investment decisions are jointly determined. This interdependence links firms' asset and liability sides and can lead to short-termism in investment. In our model, financing frictions increase with the investment horizon, such that financing for long-term projects is relatively expensive and potentially rationed. In response, firms whose first-best investment opportunities are long-term may change their investments towards second-best projects of shorter maturities. This worsens financing terms for firms with shorter maturity projects, inducing them to change their investments as well. In equilibrium, investment is inefficiently short-term. Equilibrium asset-side adjustments by firms can amplify shocks and, while privately optimal, can be socially undesirable.
Keywords: Financing Frictions; Investment Decisions; Collective Shorttermism
JEL Codes: G11; G30; G31; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financing frictions (G19) | investment decisions (G11) |
| difficult or expensive financing for long-term projects (G32) | adjustments towards shorter-term projects (F32) |
| adjustments towards shorter-term projects (F32) | inefficient short-term investment behavior (G40) |
| asset-side decisions of one firm (G32) | financing terms available to other firms (G32) |
| adjustments towards shorter-term projects (F32) | feedback loop affecting other firms (D21) |
| financing frictions (G19) | collective short-termism in the market (G14) |
| adjustments towards shorter-term projects (F32) | breakdown of financing across all maturities (G32) |
| private optimal decisions of firms (L21) | socially undesirable outcomes (P37) |
| self-reinforcing nature of the externality (D62) | amplifying shocks in the financial system (F65) |