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Contract Enforcement and Firms'd5 FinancingContract Enforcement and Firms'd5 Financing

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Author Info
Cristina Arellano (University of Minnesota and Federal Reserve Bank of Minneapolis)
Yan Bai (Arizona State University)
Jing Zhang (University of Michigan)

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Abstract

This paper studies how the degree of contract enforcement in a country influences firms'd5 financing decisions. We first document empirical facts on debt financing for two new firm-level datasets in the United Kingdom and Ecuador. In the United Kingdom, small firms borrow more relative to their assets than large firms, whereas in Ecuador small firms borrow less. We build a dynamic model of firms'd5 debt financing where debt is constrained by the likelihood of default, which varies across firms and economies with different degrees of enforcement. Because of their low firm values, small firms are mostly affected by abundance or scarcity of economy-wide loans generated by weak or strong contract enforcement. We calibrate our model to the datasets in the two countries and find that our mechanism can quantitatively account for the patterns observed in the data.

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File URL: http://www.fordschool.umich.edu/rsie/workingpapers/Papers551-575/r573.pdf
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Paper provided by Research Seminar in International Economics, University of Michigan in its series Working Papers with number 573.

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Length: 37 pages
Date of creation: Jun 2007
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Handle: RePEc:mie:wpaper:573

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