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Entry Decision, the Option to Delay Entry, and Business Cycles

Updated version coming soon!

Abstract:  I show that firms' ability to postpone entry has important implications for our understanding of the observed business cycle behavior of start-ups. I use a model that closely replicates the main features of the US firm dynamics to explore and quantify the mechanism. I find that the option to wait endogenously generates a countercyclical opportunity cost of entry: During recessions, a higher risk of failure increases the value of waiting, hence the cost of entry. The mechanism increases the elasticity of entrants to aggregate shocks five times. It is responsible for three-fourths of the observed persistent differences in the recessionary and expansionary cohorts' productivity, survival, and employment. Without the channel, existing models require either large shocks that generate excessive aggregate fluctuations or exogenous mechanisms to reconcile the observed dynamics of entrants. Overlooking this channel may also result in misleading predictions about entrants' responses to different shocks or policies.

Sovereign Risk and Economic Activity: The Role of Firm Entry and Exit 
(with Gaston Chaumont and Givi Melkadze)

New version!
Abstract: This paper quantifies the role of firm entry and exit in shaping the output costs of a sovereign debt crisis. Using annual industry-level data from European countries, we document that increased sovereign default risk is associated with a decline in firm entry and an increase in firm exits.  We find strong evidence in favor of the sovereign--bank credit supply channel in explaining the observed negative relationship between sovereign risk and firm entry, while this channel plays a minor role in the sovereign risk-exit relationship. Next, we develop a heterogeneous firm dynamics model with endogenous entry and exit, sovereign default risk, and financial frictions that successfully replicates firms' life-cycle characteristics in Portugal. We find that the increased sovereign risk accounts for 60% of the observed fall in firm entry and most of the exit dynamics during the Portuguese debt crisis. The extensive margin, in turn, plays a major role in accounting for the persistent effects of the sovereign crisis contributing to about 80% of the long-run drop in output.

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