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Financial and Legal Institutions and Firm Size

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Financial and Legal Institutions and Firm Size Thorsten Beck, Asli Demirguc-Kunt and Vojislav Maksimovic Motivation What determines firm size and how is this relevant ... – PowerPoint PPT presentation

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Title: Financial and Legal Institutions and Firm Size


1
Financial and Legal Institutions and Firm Size
  • Thorsten Beck, Asli Demirguc-Kunt and Vojislav
    Maksimovic

2
Motivation
  • What determines firm size and how is this
    relevant for SME research?
  • Firm size and institutions
  • It may be that in the absence of developed
    institutions, it is optimal for firms to stay
    small.
  • Then subsidizing SMEs to make them grow may not
    be successful or may even be counterproductive
    unless institutional shortcomings are addressed
    first.

3
Institutional Determinants of Firm Size
  • Corporate finance literature suggests that
  • financial and legal institutions could affect
    firm size in opposing ways
  • If institutions are underdeveloped, firms
    internal markets may be more efficient than
    public markets inverse relationship.
  • But large firms are also subject to agency
    problems which are more difficult to control if
    institutions are underdeveloped
  • The relationship between firm size and
    institutional development depends on the relative
    importance of these effects

4
Focus on largest firms
  • Even if with underdeveloped institutions, it is
    optimal for firms to substitute internal markets
    for external markets and become larger, financing
    constraints may prevent this blurring the
    relationship.
  • Thus, to test if transactions costs or agency
    costs are more dominant, we need to focus on
    firms that can determine their size without such
    constraints
  • Recent papers suggest that it is the largest
    firms that are likely to be the least
    constrained.

5
In this paper we ...
  • Use firm-level data for 100 largest manufacturing
    firms in 44 countries averaged over 1988-97
    (Worldscope) to examine
  • Institutional determinants of firm size
  • Are the largest firms in countries with developed
    financial systems larger?
  • Is there a positive or negative relationship
    between firm size and the efficiency of the legal
    system?
  • Are these relationships different in industries
    with a higher external financing need or higher
    ratio of intangible assets?

6
Data
  • Dependent variable total sales of firm in US
  • Independent variables financial development
    (private credit), legal development (judicial
    efficiency) and others
  • Controls firm (NFATA, NSNFA, ROA) industry
    dummies macro (GDP, GDP/CAP, inflation,
    education, openness) other institutions
    (corruption, property rights)

7
Firm Size Billions of US
8
Empirical model
  • Firm Size f( Finance, Legal, Control vbls)
  • Robustness
  • Random country effects
  • Clustering at the country and industry level
  • Multicollinearity between financial and legal
    vbls
  • Including different controls and alternative
    measures
  • Different size measure and focusing on top 25
    firms

9
Determinants of Firm Size
10
Economic Effects are also Significant
  • If Turkey had the same financial development as
    Korea (Private Credit 1.06 instead of 0.14),
    largest firms in Turkey would have been double
    the size (1.3 billion instead of 598 million)
  • If Indonesia had the same legal development as
    Chile (Jud. Eff 7.25 instead of 2.5) its largest
    firms would have been 252 million instead of
    168 million, a 50 larger size

11
Size Determinants - Channels
12
Channels
  • How does financial system impact size?
  • Firms in industries with a higher need for
    external finance are larger in countries with
    more developed financial institutions
  • Firms in industries with a naturally higher ratio
    of intangible to fixed assets are larger in
    countries with more developed financial
    institutions
  • The channels through which legal system
    effectiveness impacts firm size are not clear

13
Conclusions
  • Firms are larger in countries with more developed
    financial sectors and efficient legal systems
  • Agency costs dominate. No support for the view
    that large firms can compensate for
    underdevelopment of financial and legal
    institutions through use of internal markets.
  • Financial development allows firms to operate on
    a larger scale by facilitating access to external
    finance and a more efficient asset allocation.

14
Policy implications
  • Results suggest that optimal firm size increases
    with institutional development
  • Efforts to promote SMEs and encourage their
    growth may not be effective since optimal firm
    size is smaller in the absence of well developed
    financial institutions and efficient legal
    systems.
  • Well-developed institutions appear to be a
    pre-requisite for the development of large
    corporations.
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