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Firm Size and the Impact of the Credit Crunch on Enterprise Financing in Emerging Markets: Does Firm Size Matter

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NES 20th Anniversary Conference, Dec 13-16, 2012
Firm Size and the Impact of the Credit Crunch on Enterprise Financing in Emerging Markets: Does Firm Size Matter? (based on the article presented by Yulia Rodionova at the NES 20th Anniversary Conference).
Authors: Julia Korosteleva, University College London; UK Natalia Isachenkov, Kingston University, London, UK; Yulia Rodionova De Montfort University, UK

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Firm Size and the Impact of the Credit Crunch on Enterprise Financing in Emerging Markets: Does Firm Size Matter

  1. 1. Firm Size and the Impact of the Credit Crunch on Enterprise Financing in Emerging Markets Julia Korosteleva Natalia Isachenkova Yulia Rodionova University College London, UK Kingston University London, De Montfort University, UK UKNotes for Presentation at the 20th Anniversary of the New Economic School Conference Moscow, Russia 15 December 2012 1
  2. 2. MotivationThe paper looks at Finance for Real Investment in Small and Medium-sized Entreprises – SMEs - in the emerging markets of Europe and Central Asia during the 2007-2009 global financial crisis • Financing Constraints or Access to Finance and their Determinants • Sources of Investment Finance and their Determinants • Emphasizes the interactions of Firm Size and Crisis and of Firm Size and Trade CreditThe Rationale:Expanding access to finance presents a policy challenge that captures attention, e.g. Fraser (2009): empirical evidence that the UK SMEs face tighter constraints during the crisis Rehman (2011): for the UK firms - reports a decline in trade credit during the crisis 2
  3. 3. Motivation• SMEs finance in emerging markets in crisis times is particularly interesting sincethe small business sector is credited with innovation, job creations, reduction of income inequality … • Gorodnichenko and Schnitzer (2010), Klapper et al. (2002), Pissarides et al. (2003), Beck et al. (2005) demonstrate adverse implications of financing constraints for productivity growth at both micro and macro levels, and economic growth• Didier et al. (2011): A big impact of the crisis on exports and production, on the internationalpayments in the emerging markets of Europe and Central Asia 3
  4. 4. TheoryDeterminants of Credit ConstraintsBernanke and Gertler (1995), Bernanke, Gertler & Gilchrist (1998),Tornell and Westermann (2005) offer results consistent with RBC theory SMEs face tighter financing constraints during crises when banks are less willing to lendDeterminants of Capital Structure Modigliani-Miller’s Irrelevance in a frictionless world draws our attention to the importance of understanding financial / market frictions such as contracting costs and information costs For emerging markets’ small firms there are compelling reasons to believe the assumptions of the Modigliani-Miller (1958) theory are violated based on asymmetric information and transaction costs considerations due to opaqueness - lack of detail in business accounts, short track records … Trade-off Theory firms pick leverage by weighing the benefits (e.g. tax-deductibility) and costs (e.g. financial distress costs) of an additional unit of debt Pecking Order Theory Information costs of issuing lead to Retained Earnings being preferred to Debt, and Debt being, in turn, followed by Fresh Equity Theories tend to derive overlapping predictions – difficult to design clear empirical tests 4
  5. 5. Research Questions • For the emerging Europe and Central Asia, does the inverse relationship between Firm Size and Financing Constraints hold? • For the emerging Europe and Central Asia, does the inverse relationship between Firm Size and Financing Constraints hold for the crisis years?Pecking order Theory suggests relevance of Trade Credit FinanceCook (1999) shows that Trade Credit determines financing constraints in Russian firms • Whether SMEs of the emerging Europe and Central Asia could lessen financing constraints through: increasing Trade Credit finance / increasing Operating Financial Leverage OR increasing Owners Contribution / Fresh Equity Finance ? 5
  6. 6. Empirical Design: Data, Sample, and Explanatory VariablesFirm-level data come from 2002-2009 BEEPS Business Environment and Enterprise Performance Surveys, project of WB and EBRD12,807 firms covering 26 transition economies of Europe and Central Asia89.3 % of the firms are SMEs with fewer than 250 employees• Firm-level variables: Firm’s Size and Age, Social Capital, Pressure to Innovate, Being an Exporter, Internationally Certified Product(s), Started, and remained, as Privately Owned, Being Foreign-Owned• Institutional Variables: - Indicator of Financial Development: one-year lagged domestic credit to private sector over GDP from World Development Indicators (WB) - Property Rights Protection: one-year lagged indicator of effective constraints imposed by the executive from Polity IV• Crisis: a dummy for Years 2008 and 2009• Controls: Industry and Country Business Cycle as measured by a one-year lagged GDP growth rate, Economic Development as measured by GDP per capita 6
  7. 7. Empirical Design: Dependent Variables and Causality• Perceived tightness Financing Constraints: A dummy variable is created using responses to the question ‘Does Access to Finance – BOTH availability and cost of finance - present No Obstacle, a Minor Obstacle, Moderate Obstacle, Major Obstacle, Very Severe Obstacle to the current operations of the firm ?’ Major Obstacle and Very Severe Obstacle are coded as ‘1’• Financing Choices: Six indicators of are created using responses to the question ‘… Estimate the proportion of the establishment’s total purchase of fixed assets in the reference year that was financed from each of the following sources: 1. Internal funds or retained earnings 2. Owners’ contribution or issued new equity shares 3. Borrowed from private banks 4. Borrowed from state-owned banks 5. Purchases on credit from suppliers and advances from customers 6. Other (moneylenders, friends, relatives, non-banking financial institutions etc) ..’ We term ‘Other’ Informal FinanceThat gives us the shares of each of the capital type sought when financingreal assets• Causality: measurement of financing choices comes before measurement of constraints 7
  8. 8. Dependent Variables: Financing Constraints are a Major OR Severe Obstacle to the Current Operations of the Firm: SMEs vs. Large Firms, % 8
  9. 9. Dependent Variables: Sources of Finance for Fixed Assets Investment in SMEs, % 9
  10. 10. Empirical Results: Perceptions of Financing Constraints as a Major OR Severe Obstacle to the Current Operations of the Firm: Estimates from the Full Sample 10
  11. 11. Empirical Results: SURE Model of Financing Choices of Firms: Estimates from the Full Sample Addressing the selection bias problem. The inverse Mill’s Ratio from the 1st stage investment equation that models choice to invest in fixed assets, is added as a control to the 2nd stage SURE equation. ‘Investment ‘ Instrumented with the rate of capacity utilization. 11
  12. 12. Empirical Results: SURE Model of Financing Choices of Firms: Estimates from the Sample of SMEs Addressing the selection bias problem. The inverse Mill’s Ratio from the 1st stage investment equation that models choice to invest in fixed assets, is added as a control to the 2nd stage SURE equation. ‘Investment ‘ Instrumented with the rate of capacity utilization. 12
  13. 13. Empirical Results: Impact of Use of Trade Credit for Real Investment onPerceptions of Financial Constraints: Estimates from the Sample of SMEs ‘Use of Trade Credit’ is the relative percentage of purchases of fixed assets on credit from suppliers and advances from customers. 13
  14. 14. Conclusions SMEs appear to report tighter financial constraints The crisis makes less pronounced the differences in perceived financing constraints between small and larger firms In SMEs, increasing the proportion of Trade Credit in the financing mix, seems to lessen perceived financing constraints Trade credit channel seems important for overcoming financing constraints in the emerging markets of Eastern Europe and Central Asia 14

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