Specialization, Productivity and Financing Constraints

We analyze financial contracting when the specificity of investments is endogenous. Specialization decreases the liquidation value of assets, but it also improves a firm's long term productivity. While the first effect is known to make financing more difficult, we show that the second effect can ease financing constraints by improving an entrepreneur's incentive to pay. An entrepreneur's inability to commit to a given level of specialization introduces inefficiencies and may result in over or under specialization depending on which of the above effects dominates. The tradeoff we identify persists across various forms of specialized investments and generates new predictions. For example, we show that investment in human capital introduces a strategic incentive to specialize since entrepreneurs benefit from their investments even under liquidation.