Working Capital and Fixed Investment: New Evidence on Financing Constraints

INTRODUCTIONWorking Capital and Fixed Investment: New Evidence on Financing Constraints

AUTHOR(S)Steven M. Fazzari and Bruce C. Petersen

SOURCE The RAND Journal of Economics,

Vol. 24, No. 3 (Autumn, 1993), pp. 328-342 PUBLISHED BY:

Wiley on behalf of RAND Corporation

INTRODUCTION

This research paper is analyzing the financial constraints by emphasizing the often neglected role of working capital.

This research is explained why access to internal finance may effect firm investment and growth.

RESEARCH OBJECTIVES

The objective of this research paper is highlighting the role of working capital to overcome financial constraints on investment.

INVESTMENT IN FIXED AND WORKING CAPITALWITH FINANCE CONSTRAINTS

The role of working capitalWorking capital measures the position of firms liquid assets.

Fixed investment smoothing with working capital1. A constrained firms can not equate marginal return on

investment to the market cost of capital.2. Fixed assets smoothing should depends on its initial

stock of working capital. 3. In this sense the strength of the firm’s balance sheet

measured by its working capital can affect the link between fixed investment and cash flow.

EMPIRICAL PREDICTIONSThe two main testable predictions emerge from considering investment in fixed and working capital when firms face finance constraints: (1) Working-capital investment, when included as

an endogenous variable in a fixed-investment regression, will have a negative coefficient.

(2) The standard "within-firm" estimator will understate the full effect of internal finance on fixed investment and overstate the effect of cash flow on working-capital investment.

LITERATURE REVIEWFazzari, Hubbard, and Petersen (1988)Gertler and Hubbard (1988)Devereux and Schianterelli (1990)Hoshi, Kashyap, and Scharfstein (1991)Oliner and Rudebusch (1992)Gilchrist (1990)Himmelberg (1990)Hubbard and Kashyap (1992)Whited (1992)Carpenter (1992)Poterba (1988)

LITERATURE REVIEWBlinder and Maccini (1991)Bernanke and Gertler (1989)Calomiris and Hubbard (1990)Stiglitz and Weiss (1981)Myers and Majluf (1984)Eisner and Strotz (1963)Lucas (1967)Bernstein and Nadiri(1989)Chirinko and Fazzari (1992)Dewing (1941)Pindyck (1991)Meltzer (1960)

RESEARCH METHODOLOGYResearch Design

Time Horizon: Regression OLS Data Type: Panel Data From : 1970 – 1979 (Nine Years data) Software Employed: EViews 5.1

CONCLUSIONWhen working capital investment included in

aFixed Investment regression as use or source

offunds it has negative effect. They focus on

thebehavior of firms who virtually pay no

dividendsbecause they face binding finance

constraints.

RECOMMENDATION S In order to increase the profitability of the companies,

it is suggested to control the cost of goods sold and operating expenses.

The few companies, which did not follow a definite policy of financing fixed assets, should follow such policy.

The management should try to utilize their production capacity fully in order to reduce factory overheads and to utilize their fixed assets properly.

There has been too much of government interference in policy and day-to-day working and decisions. This leads to delays in decision-making. This should be abolished.

DEDICATION

The Most Convivial & Amiable Teacher we ever had

“SIR RAHEEL BHAGAR”