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Firm behavior in capital markets with frictions

Virginia Sarria Allende, 2004
Faculty Advisor: Charles Himmelberg


The aim of the present study is to investigate how firms' policies adjust to three different kinds of frictions, in search of optimal economical and financial structures. The first kind of friction emerges from the natural cross-sectional variation across firms; the second and third appear as a consequence of macroeconomic shocks and legal restrictions, respectively.

The first chapter analyzes the transaction motive for cash holding by firms. A cash-in-advance model is used to explore the extent to which optimal cash holdings can be explained by transaction motives. Among other things, this model shows how cash-asset ratios should vary with the firm's input mix and user cost of labor and capital. The model also predicts that firms facing tighter financial constraints adjust by holding larger cash-assets ratios.

The second chapter studies the behavior of trade credit during financial crises. It finds that although the provision of trade credit increases right after the crises-providing a sort of emergency assistance-it subsequently collapses in the post-crises. The study offers some explanation for this pattern. Additionally, the analysis of cross-sectional responses of firms with different financial positions provides results in agreement with the redistribution view, according to which bank credit is redistributed via trade credit from firms with stronger financial position to those with weaker financial stand.

The third chapter analyzes the distorting effects on industrial organization caused by entry regulation, taking advantage of heterogeneity across industries in their natural barriers and growth opportunities. The study focuses in the industries' differential responses to high levels of entry regulation: those industries without “natural” frictions appear to be more sensitive to the introduction of country-level entry regulation: industries with lower natural entry barriers respond to entry regulation by having fewer, larger and higher margin firms. There is no apparent relation, however, between natural entry barriers and overall industry share of manufacturing, as a share of entry regulation. Finally, this study shows that in countries with high entry regulation, industries respond to growth opportunities by expanding existing firms, rather than by creating new ones. Again, the total sectoral response is invariant to the level of regulation.

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