We introduce a model of endogenous growth and firm dynamics with soft budget constraints. Firms differ in innovation speed and slower firms need additional financing to eventually innovate. Because creditors cannot observe refinancing needs ex ante nor commit not to refinance at the interim stage, a Soft Budget Constraint Syndrome emerges, causing excessive entry by slow firms and crowding out potentially more efficient innovators. The resulting trade-off between positive effects of budget constraint softening on innovation by incumbents and slow-type entrants versus negative effects on entry by fast innovators generates a hump-shaped relationship between refinancing costs and aggregate growth. Calibrating the model to French firm-level data, we assess the aggregate growth impact of budget constraint softening triggered by the post–financial crisis decline in observed interest payments. Our model can explain about three-fifths of the observed drop in aggregate growth rates, of which 64% is driven by a direct effect through incumbent innovation and enhanced firm entry, and the remaining 36% arises from shifts in the firm size distribution induced by budget constraint softening.

We investigate how financial constraints affect input market dynamics in public procurement, focusing on local governments that must fulfill essential service obligations despite limited budgets. Using quasi-exogenous Federal funding allocations based on population thresholds and detailed procurement data from Brazilian municipalities, we find that increased Federal transfers reduce prices for goods and services purchased. This price decrease arises from enhanced financial conditions that lower default risk and enable larger tenders, attracting more potential suppliers to public tenders, particularly benefiting smaller firms through increased participation and contract success. Our findings highlight relationships between financial constraints, input market competition, and pricing dynamics.

This study investigates the impact of shifts in creditor control rights on the pricing of corporate loans. Using a novel hand-collected dataset, we differentiate between creditors who receive and do not receive control rights following covenant violations. This differentiation allows us to isolate the effect of shifts in control rights on loan pricing from that of other factors related to covenant violations. We find that creditors exploit control rights shifts to overprice new loans. This pricing friction in the loan market is of first-order importance in explaining loan pricing and the loan premium puzzle.