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What determines firm heterogeneity? What are the consequences of this heterogeneity for the macroeconomy? Traditionally, economists have considered a representative firm as an approximation for reality. Although such a restriction can be useful to study some questions, in reality there is a great deal of heterogeneity in firm behaviour. In this work, I look at different dimensions of heterogeneity in outcomes for firms, their sources and their implications for the macroeconomy. In Chapter 1, I propose a rich general equilibrium model of entrepreneurship, where I allow both wage workers and unemployed to start firms. I show that in this framework, the lower opportunity cost of entrepreneurship for the unemployed induces the formation of lower quality firms relative to wage workers. Using a new confidential owner-employer-employee matched dataset from Canada I test these predictions by verifying that firms created by the unemployed are on average smaller and die faster. I test the mechanism behind this result, by verifying that workers are more responsive to wage changes in their decision to start a firm relative to the unemployed. Finally, I use this framework to evaluate the impact on the economy of a public policy that promotes entrepreneurship among the unemployed. In the model presented in Chapter 2, we study the choice of an individual to start a firm as a function of their outside option as an unemployed and the implications for the efficient allocation in the economy. We show that by simply adding this additional margin to an otherwise standard general equilibrium theoretical framework, wage comparative statics become richer and the efficient allocation chosen by a benevolant social planner has a new interpretation. The chapter highlights the importance of modelling the entry margin into firm ownership in determining firm heterogeneity as well as wage dynamics. In the last chapter, we turn to the study of determinants of a firm's decision of which contract to offer a worker and the implications for wage dynamics and worker retention. We verify empirically that, due to a worker retention motive, match quality affects contract choice and wage cyclicality.
This dissertation studies two important topics in macroeconomics. The first topic is on the corporate cash hoarding. The first two chapters analyze the cash-inventory tradeoff from two different but complementary perspectives and shed light on the causes of cash hoarding. The second topic is international business cycles. A new feature of capital market is introduced into a standard international business cycle model to account for the disconnect between theory and data.The first chapter proposes an explanation for the joint dynamics of cash and inventory -- the adoption of the Just-in-Time (JIT) system. I start by demonstrating the importance of JIT in shaping corporate cash. I then develop a dynamic stochastic model to analyze the mechanisms and quantify their impacts. In the model, both cash and inventory can serve as working capital. As firms switch over from the traditional operating system (Just-in-Case, JIC) to JIT, they allocate the resources freed up from inventory to cash, in order to ensure smooth transactions with suppliers. On average, this switchover accounts for 45% and 69% of the observed cash increase and inventory decline respectively.The second chapter provides a complementary explanation for the cash-inventory joint dynamics. It models inventory as a reversible store of liquidity and studies the tradeoff between cash and inventory when a firm manages its liquidity needs. I argue that two key determinants of a firm's resource allocation decision are its market power and its exposure to risk. In the model, firms with lower market power and firms operating in riskier environments rely more heavily on cash rather than inventory. Model implications are supported by data.The third chapter studies the role of limited asset market participation (LAMP) in explaining international business cycles. We show that when LAMP is introduced into an otherwise standard model of international business cycles, the performance of the model improves significantly, especially in matching cross-country correlations. To perform formal evaluation of the models we develop a novel statistical procedure that adapts the statistical framework of Vuong (1989) to DSGE models. Using this methodology, we show that the improvements brought out by LAMP are statistically significant.