External Financial Dependence Research Articles

Stock liquidity and trade credit: Evidence from Indian firms

AbstractThe study examines the relationship between stock liquidity and the firms' extension and use of trade credit. In addition, this study examines the impact of financial constraints and dependence on external financing on the relationship between stock liquidity and trade credit. The study is based on secondary data of non‐financial Indian companies obtained from Center for Monitoring of Indian Economy Prowess database, pertaining to a period of 18 years (2000–2018). This study employs two‐step generalized method of moment's technique to arrive at results. Results of study confirm that firms with more liquid stock tend to provide more trade credit to their customers and also reduce the use of expensive trade credit financing from suppliers. Further, we find that higher stock liquidity is associated with significantly longer receivable period and shorter payable period for firms facing high financial constraints and also for firms with high external financial dependence.

External Financing Dependence and Corporate Saving in ASEAN5

Using firm-level data on ASEAN5, this paper studies the differential effects of macro-financial and structural factors on corporate saving behavior through the lens of external financing dependence. The finding suggests that non-financial corporations in ASEAN5 have been subject to binding financial constraints over the past two decades. Greater capital account openness or exchange rate depreciation reduces the average saving rate of industries with low dependence on external funds, while it increases the saving rate of industries with high dependence on external funds. The effects are greater for export-oriented industries. An improvement in banking sector competition, banks’ lending efficiency, or policy clarity is associated with lower saving rate of firms across the board.

Fettered cross-border capital flows, external finance dependence, and international trade

The effects of capital controls on international trade have not been thoroughly examined empirically. Using bilateral industry-level export data across a large number of countries, this paper evaluates how capital controls affect exports. We identify the effect of capital controls on export activities by exploiting the variation in capital controls across countries and variation in external finance dependence across industries. While we find that capital controls adversely affect total exports, analyses of the export margins indicate that the export distorting effect of capital controls works by deterring single and multiple export market entries by exporters, reducing export intensities of exporters, and the range of goods exporters can ship to each market destination. Further analysis in the paper reveals that the export distorting effects of capital controls is invariant of whether the restriction is on inward or outward capital controls, although the relative impact of inward capital control is higher. We also find that capital controls distort exports in OECD and non-OECD countries, although the effect is higher for non-OECD countries. We discuss the policy implications of the findings.

The effect of stock liquidity on investment efficiency under financing constraints and asymmetric information: Evidence from the United States

AbstractWe examine whether the association between stock liquidity and investment efficiency is more pronounced for firms with more financial constraints and information asymmetry problems. The results show that the effect of higher stock liquidity on lowering under (over)‐investment is more pronounced for firms with more financial constraints and information asymmetry problems as proxied by younger and higher business risk firms, respectively. We also find similar results for firms with lower institutional ownership, more external financing dependence and higher idiosyncratic risks. The findings collectively suggest that the effect of stock liquidity in our setting is more pervasive for firms with more financial constraints and information asymmetry problems.

Response of Manufacturing Sector to Financial Liberalization in Pakistan

It has been believed that financial liberalization can stimulate industrial growth which may be translated into overall growth of the economy by efficient allocation of credit which generates investment opportunities by reducing the cost of investment, deregulations, privatizations and reduced capital controls. This paper aims to examine the impact of financial liberalization on industrial response in manufacturing industry measured as new firm entry. Moreover, moderating effect of external finance dependence on the relationship of financial liberalization and firm entry is estimated. We estimate the model using Generalized methods of moments and found that external finance dependence has a significant negative impact of new firm entry, while financial liberalization has a positive but insignificant impact on firm entry. Nevertheless, a statistically significant positive moderating impact of external finance dependence is documented which implies that the sectors which are more dependent on external finance gain disproportionate benefit from financial liberalization.

Credit constraints, currency depreciation and international trade

We document multi-sector exporters’ heterogeneous responses to home currency depreciation. Following currency depreciation, firms tend to export relatively less in sectors that depend more on external financing, to avoid adverse impacts of potentially binding credit constraints. More specifically, credit-constrained exporters respond to currency depreciation by increasing production first in sectors with less external financing dependence, then in sectors that are more dependent on outside funds, until they exhaust their limited financial resources. These findings are consistent with our prior that exporters’ needs for external financing are greater when their home currencies depreciate. Upon home currency depreciation, exporters react by expanding production or by entering new destination markets, incurring significant upfront costs. The results survive a series of robustness checks, and are stronger for low-performance firms and for firms engaged in ordinary trade. The results have important policy implications for emerging market countries that rely heavily on exports but have weak financial institutions.

External Financing Dependence and Corporate Saving in ASEAN5

Using firm-level data on ASEAN5, this paper studies the differential effects of macro-financial and structural factors on corporate saving behavior through the lens of external financing dependence. The finding suggests that non-financial corporations in ASEAN5 have been subject to binding financial constraints over the past two decades. Greater capital account openness or exchange rate depreciation reduces the average saving rate of industries with low dependence on external funds, while it increases the saving rate of industries with high dependence on external funds. The effects are greater for export-oriented industries. An improvement in banking sector competition, banks’ lending efficiency, or policy clarity is associated with lower saving rate of firms across the board.

Total Factor Productivity Growth at the Firm-Level: The Effects of Capital Account Liberalization

This paper is the first to provide firm-level evidence of the effect of capital account liberalization on firms’ total factor productivity (TFP) growth. We find that a one standard deviation increase in capital account liberalization is significantly associated with 0.16 to 0.17 standard deviations increase of the firms’ total factor productivity growth rates. The productivity-enhancing effects are stronger for sectors with higher external financial dependence and capital-skill complementarity and are persistent in the six-year post-liberalization window. Moreover, we show that the transmission mechanisms could be improved financing conditions, technology upgrades, and more use of skilled labor. The direction and asset category of capital account liberalization matter. Additionally, heterogeneous effects exist across firms and countries based on their foreign bank relationship, size, tradability, institutional quality, and economic development.

The Aggregate and Distributional Effects of Financial Globalization: Evidence from Macro and Sectoral Data

AbstractWe take a fresh look at the aggregate and distributional effects of policies to liberalize international capital flows—financial globalization. Both country‐ and industry‐level results suggest that such policies have led on average to limited output gains while contributing to significant increases in inequality. The country‐level results are based on 228 capital account liberalization episodes spanning 149 advanced and developing economies from 1970 to the present. Difference‐in‐difference estimation using industry‐level data for 23 advanced economies suggests that liberalization episodes reduce the share of labor income, particularly for industries with higher external financial dependence, higher natural propensity to use layoffs to adjust to idiosyncratic shocks, and higher elasticity of substitution between capital and labor.

Pain or Gain? Chinese Experience of Capital Account Liberalization

AbstractThe neoclassical growth model predicts that capital account liberalization could potentially enhance economic performance; however, there is no consistent empirical evidence to support this positive association. Using a novel dataset of Chinese capital account openness, this paper demonstrates a positive relationship between capital account liberalization and aggregate economic performance. The difference‐indifferences method is used to capture the causal effect of capital account liberalization on economic performance by taking advantage of variations in both external financial dependence and the progress of capital account openness. We investigate three channels that could strengthen this positive relationship using a firm‐level dataset. We find that capital account liberalization could: (i) alleviate the degree of resource misallocation, and this effect is more significant in industries relying heavily on external finance and in regions with more favorable business environments; (ii) enhance firms’ total factor productivity; and (iii) promote innovation. Our findings suggest that a strategy of gradual openness will leave some leeway not only for improvement in domestic markets but also to mitigate exposure to unfavorable global shocks.

Inflation Anchoring, Real Borrowing Costs, and Growth: Evidence from Sectoral Data

Central bankers often assert that anchoring of inflation expectations and reducing inflation uncertainty are good for economic outcomes. We test this claim and search for a relevant channel using panel data on sectoral growth for 22 manufacturing industries from 36 advanced and emerging market economies over the period 1990-2014. Our difference-in-difference strategy is based on the theoretical prediction that inflation uncertainty has larger effects in industries that are more credit constrained by increasing effective real borrowing costs. The results show that industries characterized by high external financial dependence, low asset tangibility, and high R&D intensity tend to grow faster in countries with well-anchored inflation expectations. The results are robust to controlling for the interaction between these characteristics and a broad set of macroeconomic variables over the sample period, including the level of inflation and output volatility. The results are also robust to IV techniques, using indicators of monetary policy transparency and independence as instruments.

The value of political connections in opaque firms: Evidence from China's file 18

We examine the value of political connections in opaque firms under the setting of China's File 18. The Chinese central government has enforced File 18 since 2013 and exogenously constrained firms' political connections through independent boards. We find that the value of firms with politically-connected independent directors has significantly declined after the enforcement of File 18 only for firms with relatively higher degrees of information asymmetry. The value decline is greater among opaque firms with greater external financial dependence or lower credit worthiness, and is manifested in the drop of external financing, investments and sales growth among opaque firms. Our findings are consistent with that political connections are more conductive for firms that are more opaque by providing external financing support.

Financial constraints, institutions, and foreign ownership

We develop a model of cross-border acquisitions in which the foreign acquirer's ownership choice reflects a trade-off between easing the target's credit constraints and the costs of operating in an environment with weak institutions. Data on domestic and foreign acquisitions in emerging markets over the period 1990–2007 support the model predictions. The share of full foreign acquisitions is higher in sectors more reliant on external finance, in countries with lower financial development, and in countries with higher institutional quality. Sectoral external finance dependence accentuates the effect of country-level financial development and institutional quality. By contrast, the level of foreign ownership in partial acquisitions is insensitive to institutional factors and depends weakly on financial factors.

Social Capital, Product Market Competition and Corporate Disclosure of Proprietary Information

We examine the impact of social capital in local communities on corporate disclosure of proprietary information. Firms located in communities with higher social capital care more about the collective interests of the local communities. While the disclosure of proprietary information has the benefit of improving stock prices, the proprietary information revealed can be exploited by the firm’s product market rivals to its disadvantage and impose significant costs on both investors and the local community. Thus, when managers take the interests of local communities into consideration, they will view the disclosure of proprietary information to be a more costly action compared to those who only consider investors’ interests alone. Our empirical analysis confirms that firms located in communities with higher levels of social capital are associated with less disclosure of proprietary information. In addition, we find that the negative association between social capital and the disclosure of proprietary information is more pronounced for firms facing higher proprietary cost, with lower external financing dependence or with higher long-term institutional ownership.

Anti-Corruption Reforms and Shareholder Valuations: Event Study Evidence from China

Chinese share prices rose sharply on the Politburo’s Dec. 4th 2012 announcement of its Eight-point Regulation, an uncharacteristically detailed and concrete Party policy, initiating an extensive anti-corruption campaign and announced surprisingly soon after a change in leadership. The reaction is uniformly positive for state-owned enterprises (SOEs), but heterogeneous across non-SOEs. The reaction is more positive for non-SOEs in provinces with more developed market institutions and with higher prior productivity, greater external financing dependence, and greater growth potential. A non-SOE’s prior spending on entertainment and travel costs (ETC), a proxy for investment in “connections”, correlates negatively with the share price changes of firms based in provinces with weak market institutions. We posit that limiting corruption cuts the valuations of these non-SOEs by limiting their ability to utilize “connections” where these are more important. SOEs are well-connected in any case, and their ETC may reflect their top insiders’ perks consumption or self-dealing. Reforms that limit this boost SOEs’ valuations. Overall, these results are consistent with investors expecting the reforms to be meaningful and limiting corruption to be more valuable if prior reforms have strengthened market forces.

Gains from Early Support of a New Political Party

We study the potential benefits and mechanisms of firms' political connections by analyzing the Italian experience, where, in the early nineties, Silvio Berlusconi, a rich TV tycoon, became the leader of the conservative political coalition. Using firm-level data, we find that the 101 companies supporting Berlusconi's successful bid to become prime minister did better than controls in terms of sales and employment but not of productivity. The results are confirmed when we instrument the decision to support Berlusconi with electoral outcomes in the 1921 elections. We also find suggestive evidence that the supporters' superior performance is stronger in sectors with high external financial dependence and high advertising intensity.

Bank Competition and Industrial Structure: Evidence from China

We examine the impact of bank competition on the industrial structure using a city-industry level dataset during 2005-2009 in China. We find that bank competition increases the number of firms per capita and decreases average firm size in industries with higher external financial dependence. Bank competition affects industrial structure through increasing the proportion of SMEs. The impact of bank competition is more pronounced for private firms, and joint stock banks are the most efficient players in enhancing industrial structure. We instrument bank competition with average bank competition of other cities in the same province, and also employ the deregulation of bank branching in 2007 as a natural experiment, which confirm the robustness of our findings. Bank competition thus enhances the competition in the product market.

Credit Market Segmentation and Capital Structure Stability

The existence of corporate leverage stability is a key debate in recent capital structure studies. We propose a novel method based on within-zone leverage variations to measure the length and pervasiveness of stable leverage episodes at the firm level and identify their determinants. We find that while stability episodes exist and are widespread, they vary largely across firms. Further, we investigate a leading determinant of such episodes' length: credit market segmentation. Firms just above the investment-grade/ speculative-grade cutoff have significantly longer episodes of leverage stability than matched firms just below the cutoff. Superior access to credit for investment-grade firms is an important driver of the results. The results are stronger among firms with higher financial constraints and external finance dependence. Speculative-grade firms' violation of stable episodes arises more often due to their lower ability to raise debt. Our findings are robust to a battery of robustness checks and falsification tests. %Asymmetric disruptions in stable episodes are associated with a lower ability to raise debt among speculative-grade firms.

Within Gain, Structural Pain: Capital Account Liberalization and Economic Growth

This paper is the first to study the effects of capital account liberalization on structural transformation and compare the contribution of within term and structural term to economic growth. We use a 10-sector-level productivity data set to decompose the effects of opening capital account on within-sector productivity growth and cross-sector structural transformation. We find that opening capital account is associated with labor productivity and employment share increment in sectors with higher human capital intensity and external financial dependence, as well as non-trad-able sectors. But it results in a growth-reducing structural transformation by directing labor into sectors with lower productivity. Moreover, in the ten years after capital account liberalization, the contribution share of structural transformation decreases while that of within productivity growth increases. We conclude that the relationship between capital account liberalization and economic growth is within gain and structural pain.

Credit-supply shocks and firm productivity in Italy

The Italian economy has been struggling with low productivity growth and bank balance sheet strains. This paper examines the implications for firm productivity of adverse shocks to bank lending in Italy, using a novel identification scheme and loan-level data on syndicated lending. We exploit the heterogeneous loan exposure of Italian banks to foreign borrowers in distress, and find that a negative shock to bank credit supply reduces firms’ loan growth, investment, capital-to-labor ratio, and productivity. The transmission from changes in credit supply to firm productivity relates to labor market rigidities, which delay or distort the adjustment of firms’ desired labor and capital allocations, and thereby reduce firms’ productivity. Effects are stronger for firms with higher capital intensity and external financial dependence.