Inequality, Incomplete Contracts, and the Size Distribution of Business Firms

This paper analyzes the effects of intrafirm bargaining on the formation of firms in an economy with imperfect capital markets and contracting constraints. In equilibrium wealth inequality induces a heterogenous distribution of firm sizes allowing for firms both too small and too large in terms of technical efficiency. The findings connect well to empirical facts such as the missing middle of size distributions in developing countries. The model identifies a number of properties of the firm size distribution with respect to the wealth distribution and can encompass a non-monotonic relationship between aggregate wealth and inequality.