Industry equilibrium implications of credit market frictions

The net impact of credit supply shocks on the real economy may be reduced if firms not facing binding credit-constraints can substitute for credit-constrained firms affected by the shock. I study the importance of this substitution channel empirically by examining how a regional credit supply shock precipitated by the 1985 oil shock affected large and small manufacturing firms in oil producing states. I document a decline in employment share of small manufacturing firms in oil states following the credit shock. This decline was most pronounced in those industries where small firms had the least market power as measured by different proxies of differentiation. In those industries where small firms had the least market power, large firms headquartered in oil states experienced higher employment growth and abnormal positive stock returns. I estimate that substitution between large and small manufacturing firms after the credit shock increased total manufacturing employment in oil states by 1.3% annually between 1987 and 1990.