He Impact of the Financial System S Structure on Firms Financial Constraints

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Journal of International Money and Finance 30 (2011) 678–691

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Journal of International Money and Finance
journal homepage: www.elsevier.com/locate/jimf

The impact of the financial system’s structure on firms’ financial constraints Christopher F. Baum a, b, *, Dorothea Schäfer b, c, Oleksandr Talavera d a

Department of Economics, Boston College, Chestnut Hill, MA 02467, USA DIW Berlin, Mohrenstraße 58, 10117 Berlin, Germany Jönköping International Business School, Jönköping, Sweden d School of Economics, University of East Anglia, Norwich NR4 7TJ, UK b c

a b s t r a c t
JEL classification: G32 G30 Keywords: Financial constraints Financial structure Financial development Cash flow sensitivity of cash

We estimate firms’ cash flow sensitivity of cash to empirically test how the financial system’s structure and level of development influence their financial constraints. For this purpose we merge Almeida et al.’s work, a path-breaking design for evaluating a firm’s financial constraints, with that of Levine, who paved the way for comparative analysis of financial systems around the world. We conjecture that a country’s financial system, both in terms of its structure and its level of development, should influence the cash flow sensitivity of cash of constrained firms but leave unconstrained firms unaffected. We test our hypothesis with a large international sample of 30,000 firm-years from 1989 to 2006. Our findings reveal that both the structure of the financial system and its level of development matter. Bank-based financial systems provide constrained firms with easier access to external financing. Ó 2011 Elsevier Ltd. All rights reserved.

1. Introduction For many years, financial theory has stressed the role of financial constraints on firms’ behavior, but it has rarely considered how obstacles to external financing may vary across different financial systems. Although stock markets can play a very important role in meeting firms’ financing needs, a strong and solid banking system may be a workable alternative to meet firms’ external funding requirements. Different corporate governance systems, different regimes of investor protection, and different

* Corresponding author. Department of Economics, Boston College, Carney Hall 230, 140 Commonwealth Avenue, Chestnut Hill, MA 02467, USA. Tel.: þ1 617 552 3673; fax: þ1 617 552 2308. E-mail addresses: baum@bc.edu (C.F. Baum), dschaefer@diw.de (D. Schäfer), s.talavera@uea.ac.uk (O. Talavera). 0261-5606/$ – see front matter Ó 2011 Elsevier Ltd. All rights reserved. doi:10.1016/j.jimonfin.2011.02.004

C.F. Baum et al. / Journal of International Money and Finance 30 (2011) 678–691


corporate financing structures may all significantly influence agency conflicts, recognized as obstacles to external financing. Thus, the structure and the level of development of the financial system of a specific country may be key determinants of the financial constraints that its firms face. Anecdotal evidence documents significant differences in the structure of the financial macroeconomic environment. For instance, in 2006 the ratio of private credit by deposit money banks to GDP in Germany, 1.23, is 2.5 times higher than the same indicator in the USA, 0.48. Exactly the opposite is observed if we consider the stock market capitalization to GDP ratio for the same year: these indicators for USA and Germany equal 1.35 and 0.43, respectively. A natural question arises: in which countries are firms less likely to face obstacles in their access to external financing? To address this issue, we begin by observing the liquidity policy of firms and relating it to the degree of financial frictions they face. The traditional approach to measure financial constraints in terms of firms’ investment–cash flow sensitivity is quite controversial (e.g. Fazzari et al., 1988; Kaplan and Zingales, 1997). Therefore we follow the recently developed approach of Almeida et al. (2004), who consider a...
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