The Real Effects of Financial Constraints

86 percent of [credit] constrained firms reported they bypassed attractive investments because of concerns over raising money from outside the company [in Q4 2008, compared with only] 44 percent of unconstrained firms.

Murillo Campello, John Graham, and Campbell Harvey emailed a survey to 10,000 chief financial officers (CFOs) of public and private companies from 39 countries in the fourth quarter of 2008, asking for details of their decision making strategies during the global credit crisis. The respondents were promised anonymity, and no financial firms were included in the study. Those CFOS from the United States, Europe, and Asia who reported their firms as "credit constrained" planned to cut spending company-wide, give up attractive investment opportunities, and draw down lines of credit for fear that it would be restricted, according to The Real Effects of Financial Constraints: Evidence from a Financial Crisis (NBER Working Paper No. 15552).

The responses came from 1,050 CFOs: 574 from the United States, 192 from Europe, 284 from Asia. Of the U.S. respondents, the CFOs of 81 percent of the firms categorized as financially constrained said that they were experiencing credit rationing in the period, including a higher cost of borrowing (59 percent), and difficulties in initiating or renewing a credit line (55 percent). The responses of the European and Asian firms generally agreed with those of the U.S. firms.

Of the U.S. participants, including 130 public firms, 75 percent were classified as "small firms" -- annual sales of less than $1 billion. In that category, 41 percent of firms said they were "not affected" by credit constraints in the fourth quarter of 2008; 37 percent were "somewhat affected"; and 22 percent were "very affected." Among the large firms, with sales of $1 billion or more, 49 percent report they were "not affected"; 35 percent, "somewhat affected"; and 16 percent "very affected."

Constrained firms, on average, said they plan to cut employment by 11 percent, technology spending by 22 percent, capital investment by 9 percent, marketing by 33 percent, and dividends by 14 percent in 2009. Also, 13 percent of such firms tapped their lines of credit in order to have cash to meet expected needs, and another 17 percent did the same in case their banks shut off their credit. Few unconstrained firms report plans for significant cuts or concerns about the availability of credit during the period.

Indeed, 86 percent of constrained firms reported they bypassed attractive investments because of concerns over raising money from outside the company, while 44 percent of unconstrained firms reported a similar stance. Just over half of constrained firms reported they wouldn't take on new ventures that they planned to fund from cash flow, if they were not able to borrow in order to preserve their cash reserves, compared to 31 percent of the unconstrained firms.

Even those efforts weren't enough to stem cash run off, as constrained firms on average reported burning through one-fifth of their liquid assets during 2008. Many firms said they expected to be forced to sell off productive assets to generate operating funds.But the authors caution that some constrained firms may have had to sell assets during the crisis because they may have been over-investing before the crisis.

The authors bring a new measure of financial constraints to the literature and conclude that their results provide evidence that financial constraints hamper investment in valuable projects, reducing the strength of future economic recovery. "In this context, one can better understand why policy-makers undertook unprecedented actions to unfreeze credit markets. Relaxing these constraints would produce additional long-term growth opportunities in the economy."

-- Frank Byrt