The financing constraints hypothesis and inventory investment decisions of firms

Abstract

In the last two decades there was an increasing interest of researchers on the impact of financing constraints on investment expenses of firms. However, the vast empirical literature that followed focused, mainly, on fixed investment and less attention has been given to the effect of financing constraints on inventory investment decisions of firms (Hubbard, 1998). The present paper aims to shed some light on this relationship by testing the financing constraints hypothesis on inventory investment, for a sample of Portuguese manufacturing firms. The findings obtained appear to support the hypothesis that some types of firms face financing constraints, especially those that show a weak balance sheet position (as measured by the interest coverage ratio). These findings complement previous work by Carpenter et al. (1998,1994) and Guariglia (1999). Moreover, this paper, also, contributes to the literature by including in the analysis the effect of business risk in conjunction with the hypothesis of financing constraints. In what concerns policy implications derived from the findings of this paper, an issue that can be highlighted is its relation with the literature on business cycle fluctuations. Indeed, it is possible to say that this paper adds evidence about the existence of a “balance sheet channel” in the transmission mechanism for monetary policy, as suggested by Gertler and Gilchrist (1994) and Bernanke and Gertler (1995).