An aggregate model of firm specific capital with and without commitment

This paper considers an environment in which entrepreneurs cannot commit th eir human capitals to investment projects and the amount of external funds that they can raise is constrained by the salvage values of the physical ca pital goods. In order to raise sufficient external funds, entrepreneurs mig ht have to use capital goods that are less project specific. In a two-perio d lived overlapping generations model with aggregate shocks, this paper sho ws that the presence of the agency problem can propagate aggregate shocks t hrough the specificity of investments undertaken. (C) 2001 Elsevier Science B.V. All rights reserved.