TFP dispersion across firms rises sharply during recessions. The 90th–10th percentile spread within industries widens in each of the four recessions in the sample, consistent with the model's prediction that credit rationing intensifies when aggregate conditions deteriorate.
Cyclical Fluctuations, Financial Frictions, and Productivity Differences across Firms
Within narrowly defined industries, the most productive firms produce far more than the least productive from the same inputs, and this dispersion widens in downturns. We build a tractable model in which financial frictions—adverse selection and moral hazard—make firms sort endogenously into lenders, strategic defaulters, and producers. As credit conditions vary, the resulting misallocation gives aggregate total factor productivity (TFP) an endogenous component that accounts for about 30 percent of the variance of TFP at business-cycle frequencies, a third of it from strategic default. We show that our tractable model can match key features of the observed distribution of productivity across firms and its co-movement with output growth and credit conditions in the data.
