Firms in developing countries typically cite credit constraints as one of their primary obstacles to investment. In a recent survey of African businesses by the World Economic Forum (1997), credit constraints were cited as the third most important obstacle to doing business. The first and second obstacles listed were macroeconomic instability and political instability. Credit constraints were claimed to be even more important than infrastructure. In a similar survey of businesses in Africa by the World Bank, the primary complaint of domestic owned businesses was credit constraints. However, foreign firms did not cite credit constraints as a problem. Rather, they cited access to foreign exchange as their primary obstacle to doing business. In addition, it its not uncommon to hear development financiers complain about the lack of bankable projects.
The purpose of this paper is to test for the importance of credit constraints on investment decisions using firm level data from the Ivory Coast. In particular, we are interested in whether foreign direct investment (fdi) has an impact on domestic firms credit constraints. There are two schools of thought on this issue. On the one hand, by bringing in scarce capital may actually ease domestic firms credit constraints. Alternatively, if foreign firms borrow heavily from domestic banks, it is possible that they may actually exacerbate domestic firms credit constraints by crowding the out of domestic capital markets. One plausible mechanism by which this may happen is indirect. Foreign firms may be more experienced and have better financial and profitability ratio and thus, be a safer bet for lending institutions.
To test for the impact of fdi on domestic firms credit constraints, we follow the approach used by Bond et al (1997) of including cash flow variables in accelerator and Euler investment models. In the absence of credit constraints, cash flow should not be a significant predictor of investment. Using this approach, we also test whether in fact foreign firms are less credit constrained than domestic firms. And, we investigate the possibility that foreign firms may crowd domestic firms out of domestic capital markets.
We also compare the overall financial structure and profitability of domestic and foreign firms using standard ratio analysis. We do this to obtain more detailed information about the differences between foreign and domestic firms than can be obtained from the econometric analysis. We also do this as a first step towards understanding why it is that domestic firms might face different financial constraints than foreign firms.
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Does direct foreign investment affect domestic firms credit constraints?
