The existence of a financial accelerator mechanism : the case of the portuguese manufacturing sector

Abstract

The recent financial and economic crises that affected a large number of countries, on one hand, and the recent theoretical developments in the field of information economics, on the other, drew attention to the existence of a potential link between financial factors and fluctuations in economic activity in what concerns investment in fixed assets. An issue that has been highlighted is the possibility that fluctuations in economic activity are related and amplified by financial weaknesses of firms – the so-called financial accelerator mechanism. Based on this reasoning, this paper aims at enhancing current empirical knowledge by analysing the relationship between a firm’s investment decision and its financial position. To that purpose three hypotheses were tested: (a) the financial position of a firm is a major determinant of its capital investment decisions; (b) the financial position of a firm is more important for firms that face higher information problems in financial markets; and (c) the financial position of a firm is even more important for firms that face bigger information problems in financial markets at times of economic recession. The study herein presented, used a panel of aggregate data of sixteen Portuguese industrial sectors, covering a period of time from 1990 to 2005. The findings obtained seem to lend support to the financial accelerator hypothesis. In fact, it was found that, in general, the financial position is an important determinant of a firms’ investment decision, and that this impact is higher for smaller firms. However, the result on the influence of the business cycle was not as clear as it was expected.