Financial Constraints and Firm-Level Investment: A Panel Smooth Transition Regression Approach

Abstract

This paper provides evidence on the impact of internal finance constraints, growth opportunities and debt overhang on the firm-level investment in 14 Asian countries over the period of 1990-2010. We used Panel smooth transition regression (PSTR) that allows for time-varying effects through the use of transition functions and relaxes the assumption of a priori splitting of firms into constrained and unconstrained firms used in the linear investment models. Our results show that PSTR investment models have higher explanatory power than linear investment model. Our estimation results from the PSTR investment models show that, for firms with growth opportunities (1) investment is sensitive to availability of internal finance and (2) though firms are able to complement the internal finance with external finance but for those firms with higher leverage, the debt overhang reduces investment through a ‘liquidity’ effect. An important contribution of our research to literature is the fact that the heterogeneity of estimated Q ratio coefficients which shows effectiveness of PSTR model in explaining the changes in firm-level investment in response to the changes in the growth opportunities in the sample countries.

Keywords: Asia, Firm-Level Investment, Financial Liberalization, Under Investment; Smooth Transition Model

JEL Classification: C12, F4, G15, G32