Asymmetric Collateral Requirements and Output Composition

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Abstract
This paper studies how investment and production in an economy is allocated across sectors when they face asymmetricfinancial conditions. Namely, when investors in one sector may run projects with higher loan-to-values than in another sector. Investors decide where to invest based on total rents and face a trade-off. While theymay run larger projects in the sector with the best financial conditions, unit rents in thissector are lower than in the other sector due to a pledgeability premium. The level of interest rates affects this trade-off and therefore investors' endogenous segmentation across sectors. The effect is non-monotonic. Wheninterestratesare high, projectsare small andthedifferencesin unitrentsacross sectors dominate the differences in project sizes. In this case, a drop in interest rates, move investors toward the most productive sector. Instead, when interest rates are low, projects are large, but much larger in the sector with the best financial conditions. In this case, the differences in project sizes across sectors dominate the differences in unit rents and a drop in interest rates moves investors towards the least productive sector but with the best access to external funding. Wefind that this hump-shaped relationship betweeninterest rates and the share of investors allocated to a given sector may translate into a similar hump-shaped relationship between interest rates and the ratio of aggregate investment across sectors. Instead, in a model without financial asymmetries across sectors both relationships are monotonic and do not exhibit a hump. We claim that this paper provides helpful insights to understand the pattern of sectoral reallocation of investment and production observed in some OECD countries recently.

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