Financial Constraints, Working Capital and the Dynamic Behavior of the Firm

Financial constraints are widespread in developing countries, where even short-term credit is limited. Finance held by firms as working capital is a substantial proportion of sales revenue, yet the role of working capital is largely neglected by existing models of financial constraints. This paper presents a dynamic model of the firm that incorporates working capital by introducing a delay between factor payments and the receipt of revenue. In contrast with previous models, the working capital model predicts that firms under binding constraints will substitute between labor and capital in response to demand shocks, causing investment to be countercyclical. For firms near the margin of being constrained, constraints bind when positive production opportunities arise. Output growth is therefore constrained in response to positive shocks but not to negative shocks. Simulations suggest that models without working capital may understate the predicted effects of financial constraints on production efficiency, firm profit and growth over time. The predictions are tested with the Bangladesh Panel Survey data for manufacturing firms. Consistent with the theory, there is evidence that constraints bind when output price increases, that investment by constrained firms is countercyclical, and that output response to positive shocks is dampened for firms that are sometimes constrained. The results also are important for policy. In order to maximize growth, efforts to relieve credit constraints should be focused on periods when demand shocks are high.

Bibliographic Details

Main Author:	Chan, Rosanna
Language:	English en_US
Published:	World Bank, Washington, DC 2014-03
Subjects:	ACCELERATOR, ACCESS TO CREDIT, ACCESS TO EXTERNAL FINANCE, ACCESS TO FINANCE, ACCESS TO FINANCING, ACCOUNTING, ACCOUNTS RECEIVABLE, AFFILIATED ORGANIZATIONS, AGENCY COSTS, AMOUNT OF CAPITAL, AVAILABILITY OF CREDIT, BANK LOAN, BANKING SECTOR, BANKING SECTOR ASSETS, BASE YEAR, BINDING CONSTRAINTS, BOND, BONDS, BORROWING, BORROWING REQUIREMENTS, BUDGET CONSTRAINT, BUSINESS CYCLE, BUSINESS CYCLES, CAPITAL ACCOUNTS, CAPITAL ACCUMULATION, CAPITAL ASSETS, CAPITAL CONSTRAINTS, CAPITAL INFLOWS, CAPITAL INVESTMENT, CAPITAL MARKETS, CAPITAL RATIO, CAPITAL RATIOS, CAPITAL REQUIREMENTS, CAPITAL STOCK, CASH FLOW, CASH ON HAND, COLLATERAL, COMMERCIAL BANKS, CONSUMER SURPLUS, CONTRACT ENFORCEMENT, CORPORATE INVESTMENT, CORRUPTION, COST OF CAPITAL, COST OF FINANCE, COST OF FUNDS, CREDIT AVAILABILITY, CREDIT CONSTRAINED FIRM, CREDIT CONSTRAINTS, CREDIT MARKET, CREDIT RATIONING, DEBT, DECISION MAKING, DEVELOPING COUNTRIES, DEVELOPING COUNTRY, DEVELOPING ECONOMIES, DEVELOPMENT POLICY, DISINVESTMENT, DIVIDEND, DIVIDEND PAYMENT, DURABLE, ECONOMETRICS, ECONOMIC ACTIVITY, ECONOMIC DEVELOPMENT, ECONOMIC GROWTH, ECONOMIC IMPLICATIONS, ECONOMIC RESEARCH, EMERGING ECONOMIES, ENFORCEMENT MECHANISMS, ENTERPRISE DEVELOPMENT, ENTREPRENEURS, EQUATIONS, EQUIPMENT, EXPECTED RETURNS, EXTERNAL FINANCE, FACTOR DEMAND, FACTORS OF PRODUCTION, FARMER, FINANCE ACCESS, FINANCE CONSTRAINTS, FINANCES, FINANCIAL CONSTRAINT, FINANCIAL CONSTRAINTS, FINANCIAL DEVELOPMENT, FINANCIAL FACTORS, FINANCIAL INSTITUTIONS, FINANCIAL INTERMEDIARY, FINANCIAL MARKETS, FINANCIAL NEEDS, FINANCIAL POLICY, FINANCIAL RESOURCES, FINANCIAL SECTOR, FIRM GROWTH, FIXED INPUTS, FIXED INVESTMENT, FOREIGN BANKS, FOREIGN DIRECT INVESTMENT, FOREIGN INFLOWS, FOREIGN TRADE, GDP, GROWTH RATE, HIGH INTEREST RATES, HOLDING, HOLDINGS, ID, INCOME, INCOME EFFECT, INEFFICIENCY, INSTRUMENT, INTEREST RATE, INTEREST RATE SHOCKS, INTEREST RATES, INTERNAL FINANCE, INTERNAL FUNDS, INTERNATIONAL BANK, INVENTORIES, INVENTORY, INVESTMENT BEHAVIOR, INVESTMENT CLIMATE, INVESTMENT CLIMATE ASSESSMENT, INVESTMENT OPPORTUNITIES, INVESTMENT SPENDING, INVESTMENT-CASH FLOW SENSITIVITIES, LIMITED ACCESS, LIQUID ASSET, LIQUID ASSETS, LIQUIDITY, LIQUIDITY CONSTRAINT, LIQUIDITY CONSTRAINTS, MACROECONOMICS, MANUFACTURING INDUSTRIES, MARGINAL COST, MARGINAL PRODUCT, MARGINAL VALUE, MARKET CAPITALIZATION, MARKET INTEREST, MARKET INTEREST RATES, MARKET PRICE, MATURITY, MICROENTERPRISES, NEGATIVE SHOCK, NEGATIVE SHOCKS, NET WORTH, OPPORTUNITY COST, OPTIMIZATION, PERMANENT SHOCKS, PHYSICAL CAPITAL, PREPAYMENT, PRICE CHANGES, PRICE INCREASES, PRICE TAKERS, PRIVATE INVESTMENT, PRIVATE SECTOR DEVELOPMENT, PRODUCTION EFFICIENCY, PRODUCTION FUNCTION, PRODUCTION INPUTS, PROFIT MAXIMIZING, PROFIT OPPORTUNITY, RATE OF GROWTH, REAL INTEREST, REAL INTEREST RATE, RECEIPT, RECEIPTS, RETURN, SALES REVENUE, SAVINGS, SECONDARY MARKETS, SHORT TERM DEBT, SOURCES OF FINANCE, STOCK EXCHANGES, SUBSTITUTION EFFECT, SUPPLY SHOCKS, TERM CREDIT, TERMS OF CAPITAL, TRADE CREDIT, TRADE LIBERALIZATION, TURNOVER, VALUE OF OUTPUT, VOLATILE ENVIRONMENTS, VOLATILITY, WAGES, WEALTH, WORKING CAPITAL,
Online Access:	http://documents.worldbank.org/curated/en/2014/03/19190163/financial-constraints-working-capital-dynamic-behavior-firm https://hdl.handle.net/10986/17300
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