Financial constraints and productivity: Evidence from euro area companies

• Author: Annalisa Ferrando,Alessandro Ruggieri
• Date: 01 July 2018
• Published date: 01 July 2018
• DOI: http://doi.org/10.1002/ijfe.1615

RESEARCH ARTICLE

Financial constraints and productivity: Evidence from euro

area companies

*

Annalisa Ferrando

1

| Alessandro Ruggieri

2,3

1

European Central Bank, Frankfurt,

Germany

2

Universitat Autonoma de Barcelona,

Barcelona, Spain

3

Barcelona GSE, Barcelona, Spain

Correspondence

Alessandro Ruggieri, Universitat

Autonoma de Barcelona, Barcelona,

Spain; or Barcelona GSE, Barcelona,

Spain.

Email: alessandro.ruggieri@uab.cat

JEL Classification: D24; G32; O16

Abstract

Using firm‐level data from the Bureau van Dijk‐Amadeus database, we study

the relation between firms'financial structure, access to external finance, and

total factor productivity in several euro area countries along the period 1995–

2011. To do so, we build a synthetic indicator of financial constraints using

an a priori classification based on specific firm characteristics and measures

of financial pressure, and we embed it into a production equation, which con-

trols for the endogenous relation between labour decisions and productivity

innovations. We find a negative and significant estimate for the elasticity of

total factor productivity with financial constraints of −18%. This effect signifi-

cantly amplifies in small, young, and private companies, it is likely to persist

over time, and it increased during the recent financial crisis. A counterfactual

exercise shows that peripheral countries are likely to gain between 19% and

22% of their average total factor productivity from free access to finance. Results

are robust to several robustness checks.

KEYWORDS

cross‐country,financial constraints, productivity,sectoral analysis, SMEs

“ensuring that investment is efficiently

allocated helps create a virtuous circle

between productivity and credit”

Benoit Coure, Member of the Executive

Board of the ECB

1|INTRODUCTION

Following the recent financial crisis, there has been

renewed interest on the potential spill‐over effects from

the financial sector to the real economy.

1

On the one

hand, there is substantial evidence in the literature that

financial frictions are likely to affect firm real activities

by distorting the optimal allocation of production inputs,

either by interacting with investment in physical capital

2

or influencing firm‐level employment demand.

3

More-

over, it is well‐understood that well‐developed domestic

financial sector significantly contributes to aggregate eco-

nomic growth.

4

On the other hand, a growing number of

contributions highlight the role financial frictions, driven

by asymmetric information, agency problems, credit, and

liquidity risks, in shaping firm‐level productivity, by

*

For helpful comments, we thank Filippo di Mauro, Nezih Guner, Omar Licando, Paloma Lopez‐Garcia, Hannes Mueller, Philip Vermuelen, all the

participants of the 2013 ECB‐CompNet Workshop in Wien (Austria), the 2014 EEA‐ESEM Conference in Toulose (France), the CAED Conference

in Instanbul (Turkey), the 50th Annual Conference of Canadian Economics Association in Ottawa (Canada), and two anonymous referees. Alessandro

Ruggieri thanks the European Central Bank for his hospitality during the early stage ofthis project and acknowledge financial support from the Severo

Ochoa Program for Center of Excellence in R&D of the Spanish Ministry of Economy and Competitiveness. The views expressed are our own and do not

necessarily reflect those of the European Central Bank and the Eurosystem. All errors remain ours.

Received: 2 October 2015 Revised: 31 July 2016 Accepted: 19 December 2017

DOI: 10.1002/ijfe.1615

Int J Fin Econ. 2018;23:257–282. Copyright © 2018 John Wiley & Sons, Ltd.wileyonlinelibrary.com/journal/ijfe 257

reducing the ability and willingness of firms to engage in

productivity‐enhancing investment opportunities. A few

theoretical mechanisms linking credit conditions, invest-

ment composition, and productivity have been proposed

in the literature: the main intuition behind those theories

is that financial frictions are likely to hamper firms'pro-

ductivity by restraining investment in higher quality pro-

jects, intangible assets, research and organizational

resources, newest vintages of capital, or newest technol-

ogy. For instance, Aghion, Angeletos, Banerjee, and

Manova (2010) show that tighter credit constraints can

induce firms to bypass long‐term productivity enhancing

investment (and increase their propensity to engage in

short‐term investment) in anticipation of the higher liquid-

ity risk involved. On the same ground, Almeida and

Campello (2007) and Campello and Hackbarth (2012)

show that firms facing financing frictions are likely to

invest more in tangible assets (rather than intangible) so

to increase creditors'enforceable outside option in contract

renegotiations and benefit from the resulting larger debt

capacity. More recently, Lin, Palazzo, and Yang (2016)

and Andersen (2016) have proposed models where costly

technology adoption and external financing frictions inter-

act with each other and restrict firms'real and financial

flexibilities, bearing on firms'innovation, thus on revenues

and output per worker.

Based on these theoretical motivations, this paper

aims at providing new insights and empirical evidence

on the relation between firms'financial structure, access

to external finance, and measures of firm‐level productiv-

ity. To this extent, we exploit a large panel of firm‐level

data, tracking eight euro‐area countries (Belgium,

Germany, Spain, Finland, France, Italy, Netherlands,

and Portugal) and nine broad economic sectors (Accom-

modation and Food Service, Construction, Energy, Com-

munication, Manufacturing, Retail trade, Wholesale

trade, Transports, and Other Business Service) during

the period 1995–2011. The sample is derived from the

Bureau van Dijk‐Amadeus database which collects

accounting data of nonfinancial corporations across

Europe.

In this paper, we introduce a simple empirical

framework to make predictions about the impact of

financial constraints on total factor productivity (TFP),

and we test empirically whether access to finance mat-

ters for real value added. One of the biggest issues fac-

ing empirical works in this literature is to construct a

clean measurement of financial constraints, as they are

empirically not observable (Carreira & Silva, 2010).

Moreover, because access to finance and input decisions

are endogenously determined as equilibrium outcomes,

a further hurdle is a clear identification of the causal

direction of impact. To this regard, this paper

contributes to the literature by proposing the following

empirical strategy. As first step, we construct a classifi-

cation scheme of firms'financing conditions considering

information derived from balance sheets and profit and

loss accounts. To obtain a synthetic indicator of finan-

cial constraints, we estimate an ordered probit equation

and predict the probability for a firm of belonging to

each possible rank of our classification, conditional on

a few characteristics. Thus, we use the resulting pre-

dicted outcome (a continuous variable with higher

values associated with more constrained firms) as a syn-

thetic index of financial constraints. As second step, we

estimate the impact of limited access to finance on TFP

at a firm level. To control for unobserved productivity

shocks, we exploit the nature of our indicator, which

is by construction an additional state variable in the

firm‐level production function (together with capital

stock), and we modify the Wooldridge–Levinsohn–

Petrin methodology to accordingly account for that.

5

We use generalized method of moments to estimate a

firm‐level production function which controls for the

endogenous relation between employment decision, pro-

ductivity shocks, and financial constraints, and we then

recover TFP as residual of the regression. If financial

constraints were key determinants of productivity, these

residuals would implicitly embed their effect. Therefore,

a change in the degree of financial constraints would

result into a proportional and significant change in the

observed estimates of productivity.

In the empirical analysis, we find this effect to be neg-

ative and significantly different from zero across different

specifications and subsamples. In particular, we estimate

that a 1% fall from the average in the degree of financial

constraints predicts an increase of 0.185% in productivity.

To get rid of possible bias due to profitable opportunity

selection, we restrain the estimation to the sample of only

those firms with positive investment rates and to isolate

the effect of internal liquidity we look at firms with posi-

tive cash flow over total assets. None of these restrictions

qualitatively alter our baseline results. Looking at differ-

ent time spans, we find that productivity became more

sensitive to financial constraints during the recent finan-

cial crisis. The difference in the estimates of marginal

impacts compared with the period 1995–2007 corresponds

to an increase of roughly 16 percentage points in the elas-

ticity of productivity to financial constraints (evaluated at

the average). These results are robust to many robustness

checks, including the use of a survey‐based measure of

financial constraints.

We find that financial constraints have heteroge-

nous effects on TFP, varying across size and age cate-

gories and between public and private companies.

Micro firms (defined as those with less than 10 workers

258 FERRANDO AND RUGGIERI