Financial constraints, corporate investment and firm survival: Importance of the business cycle

Abstract

The paper analyzes the persistence of financial constraints using large sample of 1525 US firms over 1978-2006 period. The goal of this research is to reveal the persistence of financial constraints and their influence on the firm survival and the investment and cash management policies in relation to macroeconomic factors. We find the evidence that in the period following firm classification, constrained firms exhibit distinct characteristics and cash management practices, suggesting that the constraints are still in place. In addition, we find that financially constrained firms have lower survival rates. We also confirm the hypothesis that capital investment of financially constrained firms is more sensitive to changes in macroeconomic factors, showing that the capital investment of financially constrained firms is dependent on the cost and the availability of external finance determined by macroeconomic factors and that their investment decisions are to a lesser extent dictated by the state of the economy, as an opposite to unconstrained firms. The findings have important implications for policymakers as the suggest that financial constraints remain in place for a long time, even after constrained firm grow out and theoretically should get an access to capital markets. The implications of the study also concern risk management and credit analysis where financial constraints should be incorporated into models to account for higher probability of default incurred by financial constraints. Despite the fact that the research is conducted using the data from a developed economy, the findings may have important implications for emerging economies once enough data for such economies is collected and the results can be generalized.