Essays in financial frictions, entrepreneurship and economic development

This dissertation consists of three essays that study the economic implications of financial frictions on entrepreneurial investment decision making and aggregate economic performance.In the first essay, I study the effects of incomplete insurance in financial contracts on risk taking, investment horizon choice and productivity of a distribution of heterogeneous entrepreneurs. I develop a highly-stylized three-period OLG model in which young financiers are heterogeneous in terms of their liquidity needs. As a result, in the model only a fraction of financiers are patient enough to consider their long term lending opportunities. The lending options of financiers are short and long term and any combination of both which result in either short term or long term investment projects undertaken by entrepreneurs. In this setting, equilibrium investment composition (short term vs. long term) and productivity levels of entrepreneurs are determined by their intrinsic entrepreneurial ability distribution, as well as by the fraction of the patient type of financiers in the economy. When productivity improves, entrepreneurial firms increase their capital investment however, whether they shift to long term oriented projects or not is strongly linked with the liquidity needs of the financiers.Cross-country data shows a positive correlation between a nation's contract enforcement level and its ability to adopt modern technologies. In the second essay of my dissertation, I study the role entrepreneurial incentives play in shaping this empirical observation. I develop and solve a life-cycle model with limited financial contract enforcement, entrepreneurial heterogeneity (ability and financial pledgeability) and technology choice. In the model production processes can be undertaken using either the Traditional or the Modern technology. Depending on the entrepreneurial ability, the modern technology can be more productive relative to the traditional technology, but the former requires a long-term investment making entrepreneur's pledgeability important in his choice. In equilibrium the level of contract enforcement and entrepreneurial characteristics endogenously determine (1) the investment size and (2) the technology choice. Key results of the paper indicate that when financial contract enforcement is weak, the investment size and the intensity of modern technology use of entrepreneurial firms are positively correlated with financial pledgeability. Collateral-building associated with short term investment is important for the results. I calibrate the model to study its quantitative properties. Quantitative experiments illustrate sizeable positive effects of financial contract enforcement on aggregate output and aggregate modern technology adoption for the U.S. economy. Furthermore, counterfactual analysis shows that if financial contract enforcement in Turkey (a low enforcement economy) improves to the U.S. level (a high enforcement economy), output rises by 13-15% and one third of this change is due to the increase in the rate of modern technology adoption.The third essay in my dissertation provides a quantitative analysis on the effects of firm level financial characteristics in explaining the observed industry-wide productivity heterogeneity in U.S. firm level data. In the first part of the essay, I develop a model in which the interplay between capital and financial market frictions endogenously determine capital-labor ratio decisions of entrepreneurial firms. In this economy capital is costly to rent to some producers due to investment related moral hazard. Therefore, it is beneficial for such entrepreneurs to purchase the capital good instead of renting it. Entrepreneurs can internalize the cost of capital by borrowing in the financial market. However, the amount which can be borrowed is constrained by an entrepreneurs financial market reputation (pledgeability) and his financial asset liquidity (collateral). In equilibrium, firms with lower pledgeability and/or lower liquidity become more labor intensive relative to firms with higher pledgeability and/or liquidity. Distortions to capital rental rates augment the sensitivity of capital-labor choice with respect to firm level financial pledgeability and liquidity. In the second part of the essay, the analytical results are tested in a panel data analysis. Using proxies for "labor intensive production", "financial pledgeability", and "financial asset liquidity" for a large sample of U.S. firms from Compustat North America, I show that low pledgeability and low asset liquidity are associated with labor intensive production. The third part of the essay provides a quantitative analysis. I choose seven major industries in the U.S. economy. For these industries, I show that ability to borrow against financial pledgeability and asset liquidity mitigate the distortionary effects of non-uniform capital rental rates and decrease intra-industry productivity dispersion while increasing industry total factor productivity by quantitatively important proportions. However, there are differential effects of financial pledgeability and financial asset liquidity on aggregate industry performance. My results suggest that the way sectoral firms benefit from the presence of financial pledgeability and asset liquidity depend on sector specific characteristics. (Abstract shortened by UMI.)...