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 ex...
| Main Author: | |
|---|---|
| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2014
|
| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2014/03/19190163/financial-constraints-working-capital-dynamic-behavior-firm http://hdl.handle.net/10986/17300 |
| Summary: | 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. |
|---|