Yuhao Qian

Abstract: This paper exploits the Enron–Arthur Andersen accounting scandal as the first natural experiment on earnings-based financial frictions to study how earnings-based borrowing shapes capital allocation and efficiency. Using the firm-level share of issued earnings-based borrowing, I show that a 10-percentage-point decline in a firm’s share of issued earnings-based borrowing increases its marginal revenue product of capital (MRPK) growth by 6.6 percentage points among high-MRPK firms, indicating greater misallocation when the share of issued earnings-based borrowing decreases. A simple model formalizes the mechanism: collateralizing productivity via earnings, earnings-based borrowing channels funds toward more productive firms and compresses MRPK dispersion. A quantitative heterogeneous-firm model shows that tightening the earnings-based borrowing constraint generates larger TFP losses than a comparable tightening on the asset-based borrowing constraint. Taken together, the evidence highlights earnings-based borrowing as a key credit margin that supports allocative efficiency and limits misallocation.