The Thai Currency Crisis: Financing Constraints, High Fixed Costs, and Corporate Governance

Abstract

In this paper, we examined the role of financing constraints in depressing output during the crisis, using Thai firm level data. Out of a total 1998 output decline of 3.7 percent in our sample, we find that tightening financing constraints contributed to lowering output by 1.7 percent. However, most of this output decline was caused not by the deterioration in individual firm characteristics, but by the general tightening of financing constraints, say, by banking sector distress, or the tightening of monetary policy. We also found evidence of high scale economies or high fixed costs in Thai industries. With high scale economies or fixed costs, small changes in unit costs or financing costs can lead to large changes in output. We interpret the high fixed costs as evidence of overinvestment prior to the crisis. The exchange rate depreciation generally raised output. The depreciation lowered the output of non-tradeable firms, as unit costs increased by more than prices, but raised the output of tradeable firms. Output overall increased, since in our sample, tradeable firms outnumber nontradeable firms. Finally, we find that firms with close relationships with banks experienced a larger decline in output. Although the effects of deteriorating firm financial characteristics on financing constraints are moderated for firms with close banking ties, these same firms appear to have very high fixed costs. Thai firms with close banking ties were able to obtain funds cheaply from banks before the crisis; allowing the firms to become intensive in fixed assets, but making them vulnerable to rising unit and financing costs.