Financial Constraints and Capacity Adjustment in the United Kingdom: Evidence from a Large Panel of Survey Data

Abstract

Abstract:The interrelationship between financial constraints and firm activity is a hotly debated issue. The way firms cope with financial constraints is fundamental to the analysis of monetary transmission, of financial stability and of growth and development. The CBI Industrial Trends Survey contains detailed information on the financial constraints faced by a large sample of UK manufacturers. This paper uses the quarterly CBI Industrial Trends Survey firm level data between January 1989 and October 1999. The cleaned sample contains 49,244 quarterly observations on 5,196 firms. As more than 63% of the observations refer to firms with less than 200 employees, the data set is especially well suited for comparing large and small companies. The data set is presented and a new method of checking the informational content of the data is developed. Whereas the relationship between investment activity and financial constraints is theoretically ambivalent due to simultaneity, the link between financial constraints on the one hand and the prevalence and duration of capacity gaps on the other should be unambiguously positive. Looking at the relationship between both types of constraints, two important results emerge. First, there is shown to be informational content in the survey data on financial constraints. Specifically, financially constrained firms take longer to close capacity gaps. This indicates that financial constraints do indeed play a part in the investment process. Second, small firms close their capacity gaps faster than large firms do, but financial constraints seem to be of higher relevance to their adjustment dynamics. Keywords:Financial constraints, investment, capacity adjustment, small firm finance, duration analysis. We are able to explore the data base for the CBI Industrial Trends Survey (ITS), which is an important survey for business cycle analysis in the United Kingdom. For the 11 years between January 1989 and October 1999, the cleaned, unbalanced panel contains 49,244 quarterly observations on 5,196 firms. According to the CBI, the ITS represents around 33% of the total current employment within UK manufacturing. The data set covers all size ranges but specifically small firms are represented well, on which very little information is available from micro data sets based on quoted companies. More than 63% of the ITS observations refer to firms with less than 200 employees. On average, around 20.8% of respondents state that they are constrained by the lack of either internal or external financial resources, and that these constraints have an influence on their investment behaviour. JEL-Classification: D21, D92, C33, C41 Non Technical SummaryAfter describing the financing environment for small firms in the UK during the nineties, we present the data set by means of descriptive statistics. At this level of analysis, the differences between large and small firms appear modest. We proceed to examine the informational content of our data on financial constraints. Our focus is on capacity adjustment, ...

Business Optimism for Small, Medium and Large Firms: Does It Explain Investment?*

“…16 We are left with the puzzle as to why the larger companies' appetite for investment has decreased in recent years. It has been argued that financial constraints and capacity constraints are closely related and thus low investment might reflect liquidity constraints (von Kalckreuth and Murphy, 2005). However, that study pointed to this effect being strongest for small firms, whereas such firms do not exhibit a structural break in the data examined here.…”

Financial Constraints and Capacity Adjustment: Evidence from a Large Panel of Survey Data

“…This paper was written mainly while I was on secondment to the Bank of England. A more detailed working paper version (von Kalckreuth and Murphy 2005) is available at the websites of the Bank of England and the Deutsche Bundesbank. I want to thank Emma Murphy, who is co‐author of the Working Paper version, for our joint work and for the many important discussions we had.…”

Governance mechanisms, investment opportunity set and SMEs cash holdings

“…For instance, Titman and Wessels (1988) highlight that SMEs are likely to suffer from financial 1 A notable exception for the focus on SMEs is the study by Garcia-Teruel and Martinez-Solano (2008) who investigate the effect of firm financial characteristics on cash holdings for a Spanish sample. 2 According to von Kalckreuth and Murphy (2005) small and medium firms represent around 54% of the gross value added in the UK economy, 56% of employment and 52% of turnover. distress.…”