Credit constraints, fragmentation, and inter-firm transactions

In this paper, we develop a model to illustrate the effects of credit constraints on changes in organizational form and firm entry. We find net borrowers to have a greater incentive to specialize in producing fragments within the production process when internal finance plays an important role (the specialization effect). Moreover, such credit constraint-induced specialization encourages the entry of new firms (the entry effect). When the entry effect dominates the specialization effect, total output is greater under fragmentation, which is contrary to the conventional wisdom that fragmentation may lead to the double-marginalization problem and reduce output.