Earnings-based vs assets-based borrowing constraints and their impact on output

Abstract

We present an overlapping generations model in order to assess the quantitative effects of financial frictions on output depending on the type of loan contract. Financial frictions are one of the major obstacles of the business environment because firms cannot borrow all what they need. This fact creates a misallocation of resources what reduces TFP and consequently GDP. We show that the type of loan contract plays an important role in order to quantify the effects of financial frictions on TFP and per capita GDP. Recent literature has begun to distinguish between asset-based and those earnings-based loan contracts. The traditional literature used to consider only asset-based loan contracts. However, over the last years, empirical evidence shows the relevance of earnings-based loan contracts. Asset-based borrowing constraints overstate the effects of misallocation due to financial frictions. But earnings increase with productivity, so when the earnings are pledgeable, the effects on TFP caused by financial frictions are lower than when only assets are pledgeable.