Firm investment and financial conditions in the euro area: evidence from firm-level data

ABSTRACT

We explore whether the sensitivity of firm-level investment to cash flow, typically associated with an external financing premium, is time-varying and in particular whether it varies with overall financial conditions. We find that financial conditions have indeed played a significant role in corporate investment decisions over recent years, rendering financing constraints even more binding. This finding appears to be robust to a number of control variables and robustness tests. Moreover, the impact of credit conditions is not uniform across firms, but rather it varies depending on firm size and leverage, with constrained firms being substantially more likely to condition their investment decisions on overall credit conditions. Our results cast new light on the interplay between financial and real cycle downturns and underline the need for monetary, fiscal and macroprudential policy to be countercyclical with respect to financial conditions.

KEYWORDS:

• Investment
• financial conditions
• euro area
• firms

JEL CLASSFICATIONS:

• E22
• E44
• E50

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ See Balfoussia and Gibson (2016b) for a more extensive review of this literature.

² The data source is Thomsen–Reuters–Datastream.

³ The index begins in 2003 since it uses survey data from the Bank Lending Survey conducted by the ECB each month. We retain company accounts data from 1980 to facilitate the calculation of firm capital stocks. Estimations, by contrast, cover the period from 2003 onwards.

⁴ E.g. the index is averaged over April–March to match the accounting year of particular firms, and so on. The use of an average is appropriate since investment is a flow variable.

⁵ The fact that firms have a higher cash flow-conditioned propensity to invest when financing conditions deteriorate also reassures us that thefinancial conditions index is not capturing aggregate demand or sales accelerator effects.