Forthcoming , The Review of Financial Studies Specialization , Productivity and Financing Constraints ∗

We analyze optimal financial contracts when the specificity of investments is endogenous. Specialization decreases the liquidation value of assets, but it also improves the project’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 and increase financing capacity by improving an entrepreneur’s incentive to repay. The overall impact of specialization on the terms of financing depends on which effect is more important. We provide several new testable predictions about how a firm’s specialization decision interacts with the nature of investments, their timing, need for outside financing, and an entrepreneur’s ability to commit to a level of specialization. ∗We would like to thank seminar participants at Boston University, University of Cambridge, Oxford, London School of Economics, and Washington University in St Louis for valuable comments. Contact: Robert Marquez ([email protected]) or Deniz Yavuz ([email protected]). Specialization, Productivity and Financing Constraints