Financial frictions and firms’ capital composition: a structural estimation of firms’ borrowing constraints for the UK

Is it more challenging to obtain external debt financing for firms with more intangible assets? We analyse how intangible capital matters for firm-level financial frictions in the debt market and propose a novel strategy to identify them. Our empirical strategy builds on a theoretical framework and combines a standard collateral constraint with a no-arbitrage condition on firm debt. Specifically, the model predicts that the sensitivity of the firm interest rate spread to the firm capital-to-debt ratio should be decreasing in firm intangible intensity if intangibles are less effective in mitigating financial frictions. Intuitively, increasing the capital-to-debt ratio has a smaller effect on the interest rate spread for firms with more intangible assets, if the liquidation recovery value of intangible assets lower relative to that of tangible assets. Using a large panel of UK firms, we estimate the structural parameters of firms’ collateral constraint conditional on their capital composition. We find that interest rate spreads are indeed less sensitive to changes in the capital-to-debt ratio for firms with higher intangible intensity. Furthermore, a higher tangible stock lowers the firm interest rate spread, whilst a higher intangible capital stock is associated with a higher spread. Our findings are robust to controls for debt maturity and other firm characteristics commonly associated with financing frictions.