Research

Current Working Papers

Risk-Taking, Capital Allocation and Monetary Policy (with David Zeke) [Paper] revise and resubmit, Review of Economic Studies 

We study the implications of firm heterogeneity for business cycle dynamics and monetary policy. Firms differ in their exposure to aggregate risk, which leads to dispersion in costs of capital that influence micro-level resource allocations. The heterogeneous firm economy can be recast as a representative firm New Keynesian model, but where total factor productivity (TFP) endogenously depends on the micro-allocation. The monetary policy regime determines the nature of aggregate risk and hence shapes the allocation and long-run level/dynamics of TFP. Welfare losses from policies ignoring heterogeneity can be substantial, which stem largely from a less productive allocation of resources.

International Diversification, Reallocation, and the Labor Share (with Romain Ranciere and David Zeke)  [Paper] New version!!

How does growing international financial diversification affect firm-level and aggregate labor shares? We study this question using a novel framework of firm labor choice in the face of aggregate risk. The theory implies a cross-section of labor risk premia and labor shares that appear as markups in firm-level data. International risk sharing leads to a reallocation of labor towards riskier/low labor share firms alongside a rise in within-firm labor shares, matching key micro-level facts. We use cross-country firm-level data to document a number of empirical patterns consistent with the theory, namely: (i) riskier firms have lower labor shares and (ii) international financial diversification is associated with a reallocation towards risky/low labor share firms. Our estimates suggest the reallocation effect has dominated the within effect in recent decades; on net, increased financial integration has reduced the corporate labor share in the US by about 2.5 percentage points, roughly one-third of the total decline since the 1970s.

Publications

Risk-Adjusted Capital Allocation and Misallocation (with Lukas Schmid and David Zeke) Journal of Financial Economics, 145 (2022), 684-705. [Paper] [Appendix]

Editor's choice article

Winner, NASDAQ Award for the Best Paper on Asset Pricing, Western Finance Association, 2018

We develop a theory linking "misallocation," i.e., dispersion in marginal products of capital (MPK), to macroeconomic risk. Dispersion in MPK depends on (i) heterogeneity in firm-level risk and (ii) the magnitude of risk premia. Stock market-based measures imply that risk considerations explain about 25% of MPK dispersion among US firms and rationalize a large persistent component in firm-level MPK, consistent with the micro-level data. Time-varying risk premia lead to countercyclical MPK dispersion alongside procyclical capital reallocation. Risk-based MPK dispersion in part shapes the dynamic behavior of aggregate productivity, namely, its long-run level, volatility and skewness.

The Aggregate Implications of Mergers and Acquisitions Review of Economic Studies, 88 (2021), 1796-1830. [Paper] [Appendix]

This article develops a search and matching model of mergers and acquisitions (M&A) and uses it to evaluate the implications of merger activity for aggregate economic outcomes. The theory is consistent with a rich set of facts on US M&A, including sorting among merging firms, a substantial merger premium and serial acquisition. It provides a sharp link between these facts and the nature of merger gains. At the micro-level, both complementarities between merging firms and productivity improvements of target firms are important in generating gains. At the macro-level, the model suggests a significant beneficial impact of M&A on aggregate outcomes - the contribution to steady state output is 14% and 4% for consumption - which occurs through the reallocation of resources across firms and equilibrium effects on firm selection and new entrepreneurship. Nevertheless, the economy is not efficient, suggesting a scope for policy improvements - a simple flat tax on M&A can raise steady state consumption as much as 2% relative to the laissez-faire equilibrium. In short, the boundaries of the firm can matter for macroeconomic outcomes.

Capital Allocation in Developing Countries (with Venky Venkateswaran, Ana Paula Cusolito and Tatiana Didier) World Bank Economic Review, 35 (2021), 1102-21.  [Paper]

Earlier version used as background paper for The World Bank, Productivity Revisited: Shifting Paradigms in Analysis and Policy, 2018 [Book]

We investigate the sources of capital misallocation across a group of developing and developed countries, using the empirical methodology developed in David and Venkateswaran (2019). Our main findings are: (i) technological frictions - namely, adjustment costs and uncertainty - account for only a modest share of observed misallocation; (ii) heterogeneity in firm-level technologies potentially explains between one-quarter and one-half, but (iii) dispersion in markups is much smaller; (iv) after accounting for these factors, on average, at least 50% of misallocation within each country remains unexplained, suggesting a large role for additional - potentially distortionary - factors. These factors are largely attributable to a component that is correlated with firm size/productivity and one that is essentially permanent to the firm. They exhibit strong negative correlations with income per capita and direct measures of the quality of the business environment from the World Bank Doing Business survey. We report a broad set of moments describing firm-level investment dynamics and detailed parameter estimates on a country-by-country basis with an eye towards future work in this area.

Firm Performance and Macro Forecast Accuracy (with Mari Tanaka, Nicholas Bloom and Maiko Koga) Journal of Monetary Economics, 114 (2020), 26-41. [Paper] [Appendix] [NBER version] [VoxEU column]

Combining a unique survey of Japanese firms' GDP forecasts with accounting data for 25 years, we find three main results. First, firms' GDP forecasts are associated with their employment, investment, and output growth in the subsequent year. Second, over optimistic and pessimistic forecast errors predict lower profitability and productivity, consistent with our model of input choice under uncertainty. Third, larger and more cyclical firms make forecasts closer to professionals, presumably reflecting their higher return to accuracy. Forecasts by more productive and older firms are also more similar to professional forecasts, implying forecasting ability is linked to management ability and experience.

The Sources of Capital Misallocation (with Venky Venkateswaran) American Economic Review, 109 (2019), 2531-67. [Paper] [Appendix]

We develop a methodology to disentangle sources of capital 'misallocation', i.e. dispersion in value-added/capital. It measures the contributions of technological/informational frictions and a rich class of firm-specific factors. An application to Chinese manufacturing firms reveals that adjustment costs and uncertainty, while significant, explain only a modest fraction of the dispersion, which stems largely from other factors: a component correlated with productivity and a fixed effect. Adjustment costs are more salient for large US firms, though other factors still account for bulk of the dispersion. Technological/markup heterogeneity explains a limited fraction in China, but a potentially large share in the US.

Information, Misallocation and Aggregate Productivity (with Hugo Hopenhayn and Venky Venkateswaran) Quarterly Journal of Economics, 131 (2016), 943-1005. [Paper] [Appendix] [Slides]

We propose a theory linking imperfect information to resource misallocation and hence to aggregate productivity and output. In our setup, firms look to a variety of noisy information sources when making input decisions. We devise a novel empirical strategy that uses a combination of firm-level production and stock market data to pin down the information structure in the economy. Even when only capital is chosen under imperfect information, applying this methodology to data from the US, China, and India reveals substantial losses in productivity and output due to the informational friction. Our estimates for these losses range from 7-10% for productivity and 10-14% for output in China and India, and are smaller, though still significant, in the US. Losses are substantially higher when labor decisions are also made under imperfect information. We find that firms turn primarily to internal sources for information; learning from financial markets contributes little, even in the US.

Correlated Beliefs, Returns, and Stock Market Volatility (with Ina Simonovska) NBER ISoM 2015; Journal of International Economics, 99 (2016), S58-S77. [Paper] [VoxEU column]

Firm-level stock returns exhibit comovement above that in fundamentals, and the gap tends to be higher in developing countries. We investigate whether correlated beliefs among sophisticated, but imperfectly informed, traders can account for the patterns of return correlations across countries. We take a unique approach by turning to direct data on market participants' information - namely, real-time firm-level earnings forecasts made by equity market analysts. The correlations of firm-level forecasts exceed those of fundamentals and are strongly related to return correlations across countries. A calibrated information-based model demonstrates that the correlation of beliefs implied by analyst forecasts leads to return correlations broadly in line with the data, both in levels and across countries - the correlation between predicted and actual is 0.63. Our findings have implications for market-wide volatility - the model-implied correlations alone can explain 44% of the cross-section of aggregate volatility. The results are robust to controlling for a number of alternative factors put forth by the existing literature.

Federal Reserve Publications

The Rise of Intangible Investment and the Transmission of Monetary Policy Chicago Fed Letter, August 2023  [Article]

Has Covid-19 Been a "Reallocation Recession"? Chicago Fed Letter, March 2021  [Article]

Will the Covid-19 Pandemic Lead to Job Reallocation and Persistent Unemployment? Chicago Fed Letter, August 2020 [Article] [Appendix]  

Older Working Papers

The Risky Capital of Emerging Markets (with Espen Henriksen and Ina Simonovska) NBER Working Paper 20769 [Paper] [Data on Returns and Income]

We use macroeconomic data to build a panel of international capital returns over a long horizon across both developed and developing countries. We document two facts: poor and emerging markets exhibit (1) high average returns to capital and (2) high betas on US returns. We quantitatively explore whether consumption-based risk faced by a US investor can reconcile these patterns. Long-run risks lead to return disparities at least 55% as large as those in the data. Fact (2), although not a sufficient statistic, is informative about the extent of long-run risk in foreign capital, and so about fact (1).

Competition, Innovation, and the Sources of Product Quality and Productivity Growth [Paper]

This paper assesses the simultaneous impact of competition on innovative investments and achieved firm performance. I outline a structural framework to infer product quality and productivity from firm-level performance data and measure their response to changes in the competitive environment. I quantify the various channels through which competition may affect firm performance, including changing investments in R&D. Using a panel of Spanish manufacturing firms, I find that competitive pressure spurs R&D investments and performance improvements. The majority of performance gains come directly through knowledge and technology diffusion or changing managerial and worker incentives, rather than indirectly through R&D-generated innovations.

Discussions

Asset Pricing with Misallocation Winston Wei Dou, Yan Ji, Di Tian and Pengfei Wang, SFS Cavalcade North America, May 2022 [Slides]

Misallocation or Mismeasurement? Mark Bils, Peter J. Klenow and Cian Ruane, NBER Summer Institute, Economic Growth Meeting, July 2017 [Slides]

Market Power and Production (Mis)Allocation: A Study of the World Oil Market John Asker, Allan Collard-Wexler and Jan De Loecker, Becker Friedman Institute, Firm Dynamics and the Aggregate Economy Conference, May 2017 [Slides]

Currency Manipulation Tarek A. Hassan, Thomas M. Mertens and Tony Zhang, Midwest Finance Association Annual Meeting, March 2017 [Slides]

The Misallocation of Finance Toni M. Whited and Jake Zhao, Advances in Macro-Finance Tepper-LAEF Conference, September 2016 [Slides]

The Patent System as a Tool for Eroding Market Power Miroslav Gabrovski, Search, Money, Liquidity and Finance Workshop for PhD Students, spring 2015 [Slides]

Work in Progress

Merger Waves or Just Business Cycles?