Bridge over ocean
16 May 2019 CFA Institute Journal Review

Credit Constraints, Firm Investment and Employment: Evidence from Survey Data (Digest summary)

  1. Marla Howard, CFA

Using European survey data, the author finds that credit constraints have a significant impact on investment, but the effect on inventories and employment is unclear. As an incentive to increase bank lending, the European Central Bank developed targeted longer-term refinancing operations (TLTROs), which are found to reduce credit constraints and increase investment—but primarily for large and established firms.

What Is the Investment Issue?

The author investigates whether credit constraints affect investment, working capital, and employment growth. Past researchers have used indirect measures, such as balance sheet ratios or cash flow, as proxies for financial constraints. Here, the author uses firms’ answers to the Survey on the Access to Finance of Enterprises (SAFE), which directly asks management about their difficulty in accessing credit markets.

How Did the Authors Conduct This Research?

The SAFE data, sponsored by the European Central Bank and the European Commission, are gathered for 10,774 non-financial companies from 12 European countries. Primarily qualitative information from April 2014 to March 2017 is obtained from micro firms to large firms across various sectors, and the sample encompasses a wide variety of ownership structures. The author includes only firms that applied for external financing.

To evaluate the effect of external credit constraints on investment, employment, inventories, and other working capital, the author uses ordinary least squares, two-stage least squares, probit, and bivariate probit models.

What Are the Findings and Implications for Investors and Investment Professionals?

The data show that smaller firms and firms from vulnerable European countries (those at the epicenter of the sovereign debt crisis of 2009–2012) have more financial constraints. Of the sample firms, 26% report either bank or non-bank credit constraints; around 30% report increases in investment, employment, and working capital.

Financial constraints have significant negative consequences for investment in fixed assets. The effect of increasing available credit by increasing country targeted longer-term refinancing operations (TLTROs) by 1 percentage point (pp) reduces the probability of financial constraints in larger firms by 5.2 pps, but the impact is smaller for small- and medium-sized enterprises (SMEs)—only 1.4 pps—and insignificant for micro firms. In firms older than 10 years, the increased available credit reduces firm profitability by 3 pps, and there is no ease of credit constraint for firms younger than 10 years. Country TLTRO is associated with investment growth for large and older firms. The author’s results suggest that no amount of country TLTROs will ease the credit constraints on micro firms or firms younger than 10 years old. The evidence is inconclusive as to the effects of credit constraint on working capital and employment growth.

The author also uses SAFE survey data to investigate whether bank-constrained firms use other sources of non-bank financing (e.g., trade credit, grant finance, informal loans, and other types of market financing). He finds that bank-constrained firms consider, but tend not to use, non-bank financing sources.

Abstractor’s Viewpoint

The European TLTROs experiment provides an opportunity for further research on the effects of a central bank providing additional longer-term lending power to banks. It would be interesting to compare the European TLTROs project with actions by other central banks.

Because the sample includes only firms that applied for bank financing, it omits discouraged firms that did not attempt to obtain financing and also firms that have shut down. Policymakers trying to stimulate business growth might conduct surveys of those firms that did not apply for bank financing to better understand their financing constraints.

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