Rise of Superstar Firms and Fall of the Price Mechanism

Abstract

This paper investigates the impacts of superstar firms and their cash hoarding behaviors on capital misallocation through the lens of an endogenous firm-market boundary. Empirically, I find that since the 1980s, capital allocation efficiency has been deteriorating in the United States. To explain this aggregate trend, I introduce product market competition and corporate risk management into a standard continuous-time heterogeneous agent model with incomplete markets. In this framework, entrepreneurs face non-homogeneous, quality-based earnings processes, and Coase (1937)’s firm-(financial) market boundary exists in general equilibrium. The price mechanism is bounded by corporate internal financing as there is no market to equalize the marginal value of internal resources across firms. Shifts in supply and demand curves not only generate a “winners-take-most” phenomenon, but also make current winners inherently riskier and cause them to rely less on external financing. Accordingly, the increasing corporate self-financing moves the firm-market boundary and thus increases misallocation. Parameterizations of the model consistent with the data suggest that the area disciplined by the price mechanism, measured as the wealth-weighted share of firms using external financial market, has declined by roughly 11% over the past forty years.