How do banks shape firm turnover and creative destruction? This paper develops a growth model in which creative destruction is driven by the decision of banks to liquidate long-term loans with high default risk. We show analytically and quantitatively that policies aimed at encouraging more loan liquidation (e.g., reformed insolvency laws) do not only accelerate firm turnover and  improve aggregate productivity, but also foster firm creation and  boost growth. Such improvements at the exit margin complement policies designed to stimulate firm creation (e.g., start-up subsidies). The complementarity between entry and exit emerges because loan liquidation releases funds for new lending and thus relaxes the aggregate funding constraint, leading to a lower interest rate that benefits new firms. Due to this interest rate effect, tighter bank capital regulation may even increase firm creation whenever bank funding is inelastic.

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. As creditors cannot anticipate refinancing needs in advance nor credibly commit to withholding future refinancing, 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 generate 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.

What is the interaction between real interest rates and economic growth? This paper introduces a model in which real interest rates affect the direction of creative destruction through changes in financial intermediaries' portfolio allocation. Faced with regulatory or financial constraints that limit the size of their balance sheets, intermediaries evaluate new investment opportunities against the going-concern value of their legacy investments. Low real rates decrease the opportunity cost of continuing low-return projects and slow down the reallocation of capital towards high-productivity investments. A long-run decline in real rates has a hump-shaped effect on growth: When real rates are initially high, there is too much reallocation. Falling rates are expansionary. When real rates are already low, there is not enough reallocation and a further decrease depresses growth. Sustained downward pressure on real rates gives rise to a boom-bust cycle. Policies that encourage reallocation, such as tax deductions on unrealised losses, foster growth.

What is the effect of institutional ownership on economic growth? Based on previously unstudied archival data and confidential public records, I build a new data set on the historical asset allocation for the near-universe of defined-benefit pension schemes in the UK. I then exploit a change in the regulatory environment, the Pensions Act 2004, which tightened risk requirements for pension funds and led to a large divestment from equity, as a source of exogenous variation to determine the causal impact of a reduction in institutional ownership on firm-level performance. I estimate that a one percentage point drop in pension fund ownership is associated with a 1.8 percent reduction in firm-level investment per year. I also show that a smaller share of equity capital held by pension funds is associated with a shift in the composition of firm investment towards more short-term projects. In the second part of the paper, I build a Schumpeterian growth model with heterogenous investors who differ in their capacity to absorb short-term fluctuations in equity valuation due to risk-baring constraints. I calibrate the model using the firm-level estimates, and study the effect on innovation, firm dynamics, and growth.

For the last twenty years, corporate bankruptcy rates as a share of firm exit have been declining. We argue that this trend is precipitated by a rise in the importance of intangible knowledge capital and a decline in the importance of physical assets. Because the current bankruptcy code has been designed to facilitate the reallocation of physical capital between firms, it is no longer fit for purpose. This paper builds a model of creative destruction in which firms endogenously choose investment, capital structure, and bankruptcy. A rise in the importance of knowledge capital leads to an initial boom in investment and corporate bankruptcies, and to a subsequent steady decline in corporate restructuring, firm turnover, and investment. The economy's inability to restructure insolvent knowledge-intensive firms encourages the emergence of zombie firms, and culminates in a protracted growth slow-down.