Large Firm Dynamics and Financial Frictions

I consider the implications of financial frictions in industries dominated by large firms. To this end, I develop a fully dynamic model of oligopolistic firms competing under financial frictions, drawing on the dynamic games literature originating with Ericson and Pakes (1995). I show that the presence of financial constraints facing a rival firm affords an unconstrained firm a competitive advantage, which leads them to behave aggressively. By inflicting lower profits on a constrained rival, the unconstrained firm is able to gain market share in the future. The theory generates empirically testable predictions. Small constrained firms grow more slowly and the recovery of industry output following an aggregate demand shock becomes more protracted.