Contracting Frictions with Managers, Financial Frictions,

and Misallocation

Time: 16:00pm-17:30pm, Nov. 16th, 2018

Venue: Room 359S, Overseas Exchange Center, Peking University

Speaker: Chaoran Chen (Department of Economics, National University of Singapore)

Abstract:

Weak contract enforcement prevents productive firms from hiring outside managers and expanding production in developing countries. We develop a model where firms can increase their span of control by hiring outside managers, but weak contract enforcement distorts this delegation decision since managers can then steal the firm’s output unless properly incentivized. Firms overcome this friction by hiring fewer managers and increasing the compensation to managers, which manifests as output wedges at the firm level. We show that these features are consistent with cross-country evidence from the IPUMS-International data: The employment share and the wage premium of managers relative to workers are correlated with a country’s level of development. In our model, the distortionary effects are increasing in firm productivity, a necessary property any mechanism needs to generate large losses due to misallocation. We then further introduce financial frictions into our model and estimate this model using the firm-level data from China. We find that our model can account for the fact that larger firms have a higher marginal product than smaller firms, a feature of the data that standard models of financial frictions alone cannot generate. We further show that the contracting frictions generate larger productivity loss than financial frictions.

Speaker:

Chaoran Chen is currently an Assistant Professor at the National University of Singapore. Professor Chen’s research interests are in macroeconomics and economic development. His work focuses on understanding the observed cross-country productivity differences through the lens of technology adoption and resource misallocation. He also studies how capital-skill complementarity affects structural transformation and sectoral productivity. Professor Chen received his Ph.D. degree in economics from the University of Toronto in 2017. His work “Untitled Land, Occupational Choice, and Agricultural Productivity” has published on American Economic Journal: Macroeconomics.