Does Financial Liberalization Relax Financing Constraints on Firms?

50 Pages Posted: 20 Apr 2016

See all articles by Luc Laeven

Luc Laeven

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Date Written: October 2000

Abstract

Financial liberalization reduces imperfections in financial markets by reducing the agency costs of financial leverage. Small firms gain most from liberalization, because the favoritism of preferential credit directed to large firms tends to disappear under liberalization.

Laeven uses panel data on 394 firms in 13 developing countries for the years 1988-98 to learn whether financial liberalization relaxes financing constraints on firms. He finds that liberalization affects small and large firms differently.

Small firms are financially constrained before liberalization begins but become less so after liberalization. The financing constraints on large firms, however, are low both before and after liberalization. The initial difference between small and large firms disappears over time.

Laeven hypothesizes that financial liberalization has little effect on the financing constraints of large firms because they have better access to preferential directed credit in the period before liberalization.

Financial liberalization also reduces imperfections in financial markets, especially the asymmetric information costs of firms' financial leverage.

Countries that liberalize their financial sectors tend to see dramatic improvements in political climate as well. Successful financial liberalization seems to require both the political will and the ability to stop the preferential treatment of well-connected, usually large, firms.

This paper - a product of the Financial Sector Strategy and Policy Department - is part of a larger effort in the department to study the benefits and risks of financial liberalization. The author may be contacted at llaeven@worldbank.org.

Suggested Citation

Laeven, Luc A., Does Financial Liberalization Relax Financing Constraints on Firms? (October 2000). Available at SSRN: https://ssrn.com/abstract=632537

Luc A. Laeven (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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