Abstract
This article examines the effect of the level of institutional development across the different Brazilian states on the choice of external financing of Brazilian firms. Our analysis is based on a unique dataset, the Investment Climate Survey (ICS) of the Worldbank, stratified to be representative across size; 13 federal states; and 9 industry sectors.Our main results indicate that corruption and inefficiency of the judicial system have a negative impact on the access to bank credit and formal sources of funds. Financial development has a positive impact on the use of the same sources. Furthermore, this effect is more severe on smallest firms. These results suggest that low institutional development can foster financial repression, making firms rely more intensively on informal sources of funds or, otherwise, limit their investments. It also suggests that institutional underdevelopment has the perverse effect of promoting industrial concentration.
Highlights
Corporate financing choices are determined by a combination of factors that are related to the characteristics of the firm as well as to its environment
This study focuses on how the level of institutional development across the different Brazilian states explains the choice of external1 financing of Brazilian firms
We use a cross-state approach based on the existing variation across Brazilian states in terms of corruption, inefficiency of the judicial system and financial development
Summary
Corporate financing choices are determined by a combination of factors that are related to the characteristics of the firm as well as to its environment. Overall the theory suggests that imperfections resulting from conflict of interest and informational asymmetries between corporate insiders and investors constrain firms in their ability or desire to access the diverse sources of external financing The magnitude of these imperfections depends on the level of institutional development. Beck et al (2008) point out that empirical results in these papers, while consistent with the corporate finance theory, are based on narrow evidence that does not support generalization Their main shortcomings are that they 1) compare the largest firms of each country (maybe the least representative); 2) consider only two sources of external funds, debt and equity, not taking into consideration that firms may use other sources; and 3) investigate access to external capital, they do not model the firm-level self-selection that occurs when accessing a particular source of financing.
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