Working Paper: CEPR ID: DP8170
Authors: Stijn Claessens; Kenichi Ueda; Yishay Yafeh
Abstract: Financial frictions have been identified as key factors affecting both short-term economic fluctuations and long-term growth. An important policy question therefore is whether institutional reforms can reduce financial frictions and, if so, which reforms are best? We address this question by empirically investigating the effects of institutions on financial frictions using a canonical investment model. We consider two channels by which frictions affect investment: (i) through financial transaction costs at the individual firm (micro) level; and (ii) through the required rate of return at the country (macro) level. Using a panel of 75,000 firm-years across 48 countries for the period 1990-2007, we examine how, through these frictions, institutions affect investment. We find that improved corporate governance (e.g., less severe informational problems) and enhanced contractual enforcement reduce financial frictions affecting investment, while stronger creditor rights (e.g., lower collateral constraints) are less important.
Keywords: Corporate Governance; Creditor Rights; Financial Friction; Institutions; Investment
JEL Codes: G30; O16; O43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Improved corporate governance (G38) | Reduced financial frictions (G19) |
| Reduced financial frictions (G19) | Increased investment (E22) |
| One-standard deviation increase in antidirector rights index (G34) | Decrease in required rate of return (G19) |
| Stronger creditor rights (G33) | Alleviation of collateral constraints (D10) |
| Stronger creditor rights (G33) | Reduced financial frictions (G19) |