Abstract
Using a firm-level survey database covering 48 countries, we investigate how financial and institutional development affects financing of large and small firms. Our database is not limited to large firms but includes small and medium-size firms and data on a broad spectrum of financing sources, including leasing, supplier, development, and informal finance. Small firms and firms in countries with poor institutions use less external finance, especially bank finance. Protection of property rights increases external financing of small firms significantly more than of large firms, mainly due to its effect on bank finance. Small firms do not use disproportionately more leasing or trade finance compared with larger firms, so these financing sources do not compensate for lower access to bank financing of small firms. We also find that larger firms more easily expand external financing when they are constrained than small firms. Finally, we find suggestive evidence that the pecking order holds across countries.
Highlights
Recent papers studying financing patterns around the world emphasize the importance of institutional differences across countries on capital structure (DemirgucKunt and Maksimovic, 1999; Booth, Aivazian, Demirguc-Kunt, and Maksimovic, 2001; and Fan, Titman, and Twite, 2003)
These results suggest that small firms cannot substitute other financing sources such as leasing, trade, or development finance for the lower access to bank finance
The significantly higher use of informal finance compared with large firms is not sufficiently large to offset the lower use of bank finance
Summary
Recent papers studying financing patterns around the world emphasize the importance of institutional differences across countries on capital structure (DemirgucKunt and Maksimovic, 1999; Booth, Aivazian, Demirguc-Kunt, and Maksimovic, 2001; and Fan, Titman, and Twite, 2003). Even after we control for various firm characteristics and country and institutional variables, smaller firms finance a lower proportion of their investment externally, because they make use of bank finance to a lesser extent. Investigating the linkages between firm size and the impact of institutional development on financing patterns, we see that small firms benefit disproportionally from higher levels of property rights protection by using significantly more external finance, from banks. These findings point out the limits to small firms’ ability to compensate for the underdevelopment of their countries’ financial and legal systems In these countries, the alternative sources of finance either do not significantly fill the gap or, in the case of trade credit, are less prevalent. We use firm-level survey data to investigate the proportion of investment firms finance externally, focusing on the differences between small and large firms.
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