Institutions, Financial Frictions, and Investment: Estimation with Structural Restrictions
58 Pages Posted: 12 May 2012
Date Written: May 7, 2012
We investigate the relations among country-specific institutions, financial frictions, and firm-level investment decisions. Imposing structural restrictions, we consider the effects of institutions (such as shareholder and creditor rights) on firm investment through two channels: the cost of capital at the firm (micro) level; and the required rate of return at the country (macro) level. Using a panel of 75,000 firm-years from 48 countries for the period 1990-2007, we find that: (i) country-level institutions affect firms’ investment behavior; (ii) shareholder rights affect financial frictions and investment more than other institutions (e.g., product market competition, creditor rights) do; and (iii) effects are especially pronounced for small firms with large financing needs, suggesting that stronger shareholder rights lead to a more efficient allocation of capital.
Keywords: Financial friction, investment, Tobin’s Q, institutions, investor protection
JEL Classification: G30, O16, O43
Suggested Citation: Suggested Citation