Financial constraints and firms’ activities in China

Abstract

The understanding the effects of financial constraints and firms’ activities is an important issue from both macroeconomics and microeconomics perspectives. The recent development of the asymmetric information approach has established a link between finance and the real activity. A good understanding of the effects of financial constraints and firms’ activities would provide valuable information about the mechanism through which monetary policy affects real economic activities and the understanding of the macroeconomic dynamics. From a microeconomics perspective, the study of the effects of financial constraints also contributes to the understating of firms’ corporate finance behaviors and the importance of firm heterogeneity in firms’ activities. This research uses two large samples of firm-level panel data from China to study the effects of financial constraints on three key firm activities.

First, using an Euler equation investment model, we empirically study the effects of financial constraints on firms’ fixed investment in China over the period 1998-2005. We find strong evidence indicating there is a “lending bias” at work. Where the state-owned enterprises and collectively owned enterprises are less financially constrained that privately owned firms. The evidence also suggests that listed firms are more financially constrained than unlisted firms. Moreover, the results indicate that the presence of foreign ownership helps to reduce the level of financial constraints faced by firms.

Second, we use an error correction model augmented with cash flow to test the effects of financial constraints on firms’ inventory investment in China with emphasis on the firm heterogeneity. We find that cash flow is an important determinant for inventory investment of privately owned firms, foreign owned firms, firms with no political affiliations to the central or local governments. The result also suggests that the level of financial constraints faced by firms increased over the study period.

Last, we test whether there is a link between financial factors and firms’ export decisions in China. We find that firms’ liquidity and leverage levels are important determinants of firm’s exports participation decisions, where the effects are strongest for privately owned firms. When we focus on the exports participation decision of the private firms, we find financial factors are particular important for firms that are smaller, younger and with no political affiliations.