A Stochastic Frontier Analysis of Financing Constraints on Investment: The Case of Financial Liberalization in Taiwan

Abstract

We show that investment under financing constraints can be modeled as a one-sided deviation from a frictionless investment level, and that effects of financing constraints can be identified and quantified by imposing a distributional assumption on the effects. Panel data on Taiwanese manufacturing firms between 1989 and 1996 are used in the estimation. This period chronicles important financial reforms in the Taiwanese markets, thus providing a unique opportunity to test the financing constraint hypothesis. Estimation results show that cash flow not only have the first order effect of reducing the level of constraints, but also has the second order effect of reducing the variance of the constraints. The use of the quantitative measures of financing constraints in the post-estimation analysis yields two interesting findings: (1) Some of the sorting criteria used in the literature do not have significant and monotonic relationships with the degrees of financing constraint, resulting in problematic sample separations. (2) The effects of financial liberalization in Taiwan are such that the investment efficiency improved over time for a typical firm, and the improvement was particularly large for smaller firms.

Keywords: financing constraints, stochastic frontier, financial liberalization

JEL Classification: C33, E22, E44