Investment efficiency among a cross-section of UK firms:implications for the debate on financing constraints

In this paper, we address this policy issue using a stylised methodology that relies on estimates of the cash flow sensitivity of firms’ investment, as well as a relatively new methodology that enables us to generate a (0, 1) bounded measure of investment efficiency of firms, i.e., the efficiency with which firms can convert their sales into investment, after controlling for unobserved year- and industry-specific effects. Higher investment efficiency is associated with lower financing constraint. Our results indicate that there is considerable heterogeneity in investment efficiency across firms, during a given year; the range being 0.57-0.82. However, the average investment efficiency measure is similar across years, regions and NACE 2-digit industries. We also do not find discernible patterns in the relationship between investment efficiency and firm size, both before and during the financial crisis. The results suggest that while some firms are clearly less efficient at translating their performance into investment, broad policies targeting firms of a certain size, or those within a particular industry or region, may not successfully address the problem of financing constraint in the United Kingdom. The targeting of firms with financing constraints may have to be considerably more refined, and look at not easily observable factors such as credit history/events and organisational capacity of the firms.

A note on a semiparametric approach to estimating financing constraints in firms

In this paper, we present a novel approach to modeling financing constraints of firms. Specifically, we adopt an approach in which firm-level investment is a nonparametric function of some relevant firm characteristics, cash flow in particular. This enables us to generate firm-year specific measures of cash flow sensitivity of investment. We are therefore able to draw conclusions about financing constraints of individual firms as well as cohorts of firms without having to split our sample on an ad hoc basis. This is a significant improvement over the stylized approach that is based on comparison of point estimates of cash flow sensitivity of investment of the average firm of ad hoc sub-samples of firms. We use firm-level data from India to highlight the advantages of our approach. Our results suggest that the estimates generated by this approach are meaningful from an economic point of view and are consistent with the literature. © 2014 © 2014 Taylor & Francis.