51 Pages Posted: 19 Jul 2012 Last revised: 18 Sep 2012
Date Written: July 1, 2012
We study how the availability of domestic credit influences the contribution that financing activities make to a firm’s return on equity (ROE). Using a sample of 51,866 firms from 69 countries, we find that financing activities contribute more to a firm’s ROE in countries with higher domestic credit. The higher contribution of financing activities is not driven by firms taking greater leverage in these countries, but by firms realizing a higher spread (i.e., a greater difference in operating performance and borrowing cost) when more domestic credit is available. Also, we find that firms partially substitute trade credit for financial credit, with large firms exhibiting the greatest rate of substitution. For small firms, the rate of substitution improves with the country’s available domestic credit, while large firms are insensitive to this friction. The findings suggest that both country and firm-level factors have a significant impact on how financing activities contribute to corporate performance.
Keywords: Domestic Credit, Financial Statement Analysis, Return on Equity, Corporate Performance
JEL Classification: F30, G15, M40
Suggested Citation: Suggested Citation
Lundholm, Russell J. and Serafeim, George and Yu, Gwen, FIN Around the World: The Contribution of Financing Activity to Profitability (July 1, 2012). Harvard Business School Accounting & Management Unit Working Paper No. 2113557. Available at SSRN: https://ssrn.com/abstract=2113557 or http://dx.doi.org/10.2139/ssrn.2113557
By Ross Levine