We use cookies to distinguish you from other users and to provide you with a better experience on our websites. Close this message to accept cookies or find out how to manage your cookie settings.
We use cookies to distinguish you from other users and to provide you with a better experience on our websites. Close this message to accept cookies or find out how to manage your cookie settings.
Published online by Cambridge University Press: 21 October 2015
Is there econometric evidence that liberalization has succeeded in relaxing financial constraints faced by individual establishments? This chapter investigates the issue by estimating a simple form of the investment function for the panel of individual establishments.
Introduction
Our basic theoretical view is that Indonesian manufacturing establishments increase their capital stock through investment in response to potential profitearning opportunities. Desired investment can be financed in a number of ways, the two most important being borrowing from the credit market and retention of cash flow (internal finance). If capital markets are perfect and taxes are absent, firms will be indifferent between various sources of funds. They will finance their investment at a constant marginal cost that is closely related to the risk-free market interest rate, and they will invest until the latter is equated with the expected marginal return to investment. In such a world, only the constant marginal cost of funds and rate of return to investment are important for the investment decision and the former should be closely related to the risk-free market interest rate.
However, even in perfect markets there will be constraints to borrowing because of asymmetric information, monitoring costs, and other factors, which make fixed-interest-rate lenders willing to lend a higher proportion of the costs of proposed investments only at increasing interest in order to compensate for the increased risk. The premium charged will depend on the value of the firm's assets that can be used as collateral. This is referred to in the literature as agency costs. Therefore, a negative association is expected between increasing divergence between average and marginal interest rates for individual borrower firms as the degree of financial leverage increases.
If markets are segmented so that some classes of firms have limited access to borrowing, they will be forced to rely on internally generated funds and may have to forego some desired investment because of financial constraints.
To save this book to your Kindle, first ensure [email protected] is added to your Approved Personal Document E-mail List under your Personal Document Settings on the Manage Your Content and Devices page of your Amazon account. Then enter the ‘name’ part of your Kindle email address below. Find out more about saving to your Kindle.
Note you can select to save to either the @free.kindle.com or @kindle.com variations. ‘@free.kindle.com’ emails are free but can only be saved to your device when it is connected to wi-fi. ‘@kindle.com’ emails can be delivered even when you are not connected to wi-fi, but note that service fees apply.
Find out more about the Kindle Personal Document Service.
To save content items to your account, please confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. Find out more about saving content to Dropbox.
To save content items to your account, please confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. Find out more about saving content to Google Drive.
