Abstract

We study optimal cash management, innovation, and production decisions for a continuum of firms facing financing frictions and the threat of creative destruction. We show that while financing frictions prompt firms to decrease production, they may spur investment in innovation. We examine which types of firms substitute production for innovation in response to negative operating shocks that decrease cash availability. We embed our firm dynamics into a model of endogenous growth and show that financing frictions have contrasting effects on the equilibrium rate of economic growth.

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