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Previous studies have underlined various rationales for production fragmentation from wage differentials, decreased trade costs, access to specialized skills and resources, access to new markets, and benevolent government policies, to technological advancement. However, the idea that a firm’s financing structure can influence its production structure remains less explored, more so empirically. Firms that are financially constrained find it difficult to complete the entire production process in-house and therefore tend to resort to production fragmentation. The current study investigates this link between the extent of credit constraints faced by firms and their outsourcing behavior using data from Indian manufacturing firms over a period of ten years. We also separately study this linkage for firms that tend to export more vis-à-vis firms that export less, to ascertain if increased exporting have relaxed the financial constraint of the firms. The results confirm the positive effect of credit constraints on outsourcing behavior. For a robustness check, subsample regressions and alternative measures of constraints are also analyzed. The study has important policy implications for developing countries such as India, where outsourcing may prove to be a profitable reorganization strategy for firms that are financially constrained.

Firms under financial constraints depend more on their internal funds when it comes to financing their investment and production activities due to a dearth of external finances. This paper conducts a study on Indian manufacturing firms for the period 2010-2019 to explore the usefulness of cash-flow sensitivity of investment as a measure of financial constraints. The study also focuses on the determinants of investment under financial constraints. Firms have been classified into financially constrained and unconstrained firms based on some a priori observable indicators, such as the prevailing uncertainty, business group affiliation, and market capitalization. The result provides evidence that the investment decision of financially constrained firms faces a higher degree of cash-flow sensitivity. Furthermore, asset tangibility is found to reduce the financial constraints of firms, thereby uplifting investments.

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