Financing Constraints, Radical versus Incremental Innovation, and Aggregate Productivity

I provide new empirical evidence on the negative relationship between financial frictions and productivity growth over a firm’s life cycle. I show that a model of firm dynamics with incremental innovation cannot explain this evidence. However, further including radical innovation, which is very risky but potentially very productive, allows for the joint replication of several stylized facts about the dynamics of young and old firms and the differences in productivity growth in industries with different degrees of financing frictions. These frictions matter because they act as a barrier to entry that reduces competition and the risk-taking of young firms.