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Testing for the impact of financing constraints on corporate investment

Benedicte Millet-Reyes, 1998
Faculty Advisor: R. Glenn Hubbard

Abstract

Corporate access to external funds has a significant impact on the firm's financial decisions and on its cost of capital. This dissertation provides a literature review as well as new empirical tests of how financing constraints may modify corporate investment in physical and knowledge capital.

In the first study, I investigate how information asymmetries between a firm and its providers of external funds may affect the rate of return to R&D investment. If a company has to pay a premium on its cost of knowledge capital because of adverse selection problems, it will also require a higher rate of return on its research projects. However, this hypothesis has never been tested in the productivity literature since authors usually concentrate on technological incentives to invest in R&D. By augmenting a Cobb-Douglas production function with a first-order condition on the cost of research capital, I provide a theoretical framework where the impact of financing constraints can be measured. An empirical study of U.S. manufacturing firms is then conducted to test whether companies with limited access to external financing require a higher rate of return on their research projects.

The second part of this dissertation provides new evidence on corporate investment in France. Access to public financial markets may be less important in countries that have traditionally relied on institutional investors to finance their corporate investment projects. This should be true for France where, contrary to the U.S., national banks have always been involved in firms' long term activities. By using data I collected on the ownership structure of French firms, I study how the deregulation of French economy affected corporate investment between 1983 and 1990. First, a Tobin's Q model is augmented with measures of corporate liquidity in order to test the impact of internal funds on investment. Only small French firms trading on the secondary stock market have to rely on working capital accumulation to finance their capital expenditures. French firms with strong bank ties avoid this problem by being allowed to maintain higher debt levels. Second, I use an Euler equation model to assess the impact of borrowing constraints on corporale investment. Again, only small French companies without bank ties reject the baseline model without a credit limit.

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