Firm Entry and Financial Shocks

Abstract

This article shows that firm entry dynamics are an important part of the propagation of financial shocks to the real macroeconomy. A VAR documents empirically that adverse financial shocks are associated with significant declines in both new firm creation and equity values. A DSGE business cycle model combining endogenous firm entry and financial frictions, where firms have a choice of financing entry through debt or equity, can explain these facts. The model implies that adjustment in firm numbers can moderate the impact of financial shocks on aggregate output, as it buffers the equity value and financial stance of surviving firms.