The impact of recent financial shocks on the financing and investment policies of UK private firms

Abstract

This study examines how shocks to the supply of credit during the financial crisis of 2007–2009 affect the financing and investment policies of private companies in the United Kingdom. To investigate this issue we adopt a fixed effects model as our research methodology. Our final sample includes a total of 4973 firms. Our results highlight that the recent credit crisis has adversely affected the leverage ratio of private firms. This effect is most significant on short term financing channels such as short term debt and trade credit. As a consequence, private firms hold cash and issued equity for hedging the negative effect of credit contractions. However, no evidence was found on the issue of net debt issue or obtaining longer trade credit as substitutes for preserving their financial slack by the private firms. The results also revealed, that private firms did not scale back shareholder distribution in response to their financial difficulties. The results further highlight that credit contraction has negatively affected the performance and investment of private firms. Moreover, the increase in cash reserve and decrease in investment would suggest that firms may have raised funds through equity for managing their cash balances. Overall, the results highlight that financial and investment policies of private firms are susceptible to variations in the supply of credit and firms which are unable to find alternative sources of finance may bear a much larger cost compared to those who manage their financing more appropriately. Our findings have implications for the ongoing financial crisis as well as future policy designs by monetary and banking authorities.