A Working Capital Theory of the Firm and Empirical Evidence.

Abstract

Firms under financial constraints exhibit different behavior from firms that are not financially constrained. This dissertation formalizes a working capital theory of the firm that captures the effects of financial constraints on the behavior of the firm that the standard theory of the firm would otherwise not capture. The first chapter develops the working capital model of the firm and show that under very few assumptions, the dynamic model is easily tractable to a static solution. The model predicts that under financial constraints, firms would exhibit countercyclical investment behavior. Furthermore constrained firms are constrained particularly during times when there are positive price shocks and as such, this has large implications for growth. These predictions are supported by empirical analysis using a unique panel of Bangladeshi firms. The second chapter extends the working capital theory of the firm to examine the implications of financial constraints on exports. Exporting requires greater liquidity demands due to greater transport time. As such, the model shows that the established relationship between exporting and productivity differs under financial constraints. The theoretical result shows that export status is less dependent on productivity and more dependent on the availability of working capital when firms are constrained, and this is supported by empirical analysis and results. The third chapter utilizes the difference in the behavior between financially constrained and unconstrained firms to examine the effect of bribes on firm growth. Empirical results suggest that the effect of bribes of firm growth differs significantly between constrained and unconstrained firms, with the former having a significant negative effect. The interaction between financial constraints and bribes show that bribes can be distortionary even when bribes act as fixed costs. These results imply that corruption alone may not be detrimental to firm growth but when combined with limited access to finance, the cost of corruption seriously hampers the growth of firms.