Financial Frictions, Investment, and Institutions

Stijn Claessens (), Yishay Yafeh and Kenichi Ueda

No 8170, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Financial frictions have been identified as key factors affecting both short-term economic fluctuations and long-term growth. An important policy question therefore is whether institutional reforms can reduce financial frictions and, if so, which reforms are best? We address this question by empirically investigating the effects of institutions on financial frictions using a canonical investment model. We consider two channels by which frictions affect investment: (i) through financial transaction costs at the individual firm (micro) level; and (ii) through the required rate of return at the country (macro) level. Using a panel of 75,000 firm-years across 48 countries for the period 1990-2007, we examine how, through these frictions, institutions affect investment. We find that improved corporate governance (e.g., less severe informational problems) and enhanced contractual enforcement reduce financial frictions affecting investment, while stronger creditor rights (e.g., lower collateral constraints) are less important.

Keywords: Corporate governance; Creditor rights; Financial friction; Institutions; investment (search for similar items in EconPapers)
JEL-codes: G30 O16 O43 (search for similar items in EconPapers)
Date: 2010-12
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Citations: View citations in EconPapers (6)

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