Internal Capital Markets and Financing Choices of Mexican Firms Before and During the Financial Paralysis of 1995-2000

This paper shows that, contrary to conventional wisdom, once the Mexican economy moved from financial liberalization to financial paralysis in 1995, liquidity constraints were relaxed for many large and financially healthy firms listed on the Mexican Securities Market. In the latter period, only those firms with a banking tie observe, on average, a dependence on cash stock to finance their investment projects. Econometric results are derived from dynamic panel data models estimated with the Generalized Method of Moments, where level and difference equations are combined into a system. The econometric evidence is consistent with the real growth of the Mexican economy during the years 1996-2000, which took place in a context of a collapsed banking system and the paralysis of other domestic forms of external financing. This paper also provides evidence supporting the hypothesis that firms’ membership in a network and firms’ linkage to a bank produced weaker financial constraints before the banking crisis. However, additional research is needed to formally test the importance of the different sources of financing since 1995; suppliers’ credit, foreign funding and internal capital markets are viable candidates for further study. Finally, the paper provides an intuitive rationalization of the Mexican paradox based on the business groups’ structure and their internal capital markets. It is argued that under a macroeconomic setting characterized by disarray in the domestic financial system, firms affiliated with business groups have more incentives to act coordinately rather than performing as autonomous profit centers. Consequently, in this new scenario, corporate headquarters are more interested in removing financial bottlenecks than in exerting market pressure on their divisions. In this environment, groups are capable of reallocating financial resources away from booming, export-oriented affiliates—the most likely to have access to foreign capital markets—and into cash-constrained firms within the same group. In other words, according to this theory, it is suggested that the presence of internal capital markets worked as a financial buffer that helped sustain economic growth.