Financial Frictions, Investment, and Institutions
46 Pages Posted: 1 Feb 2011
Date Written: October 2010
Financial frictions have been identified as key factors affecting economic fluctuations and growth. But, can institutional reforms reduce financial frictions? Based on a canonical investment model, we consider two potential channels: (i) financial transaction costs at the firm level; and (ii) required return at the country level. We empirically investigate the effects of institutions on these financial frictions using a panel of 75,000 firm-years across 48 countries for the period 1990-2007. We find that improved corporate governance (e.g., less informational problems) and enhanced contractual enforcement reduce financial frictions, while stronger creditor rights (e.g., lower collateral constraints) are less important.
Keywords: Business cycles, Corporate governance, Corporate sector, Development, Economic growth, Economic models, Investment
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