GGDC Research Memorandum Nr. 120

Title: Does Access to Finance Lower Firms' Cost of Capital? Empirical Evidence from International Manufacturing Data

Author(s): Addisu A. Lashitew

Abstract: Lack of access to finance is argued to be one of the most binding constraints for firm growth. Faced with financing constraints that raise their cost of capital, small firms fail to build up their capital stock and lower their marginal revenue of capital. This paper uses a unique, international, manufacturing dataset to examine if financial access indeed lowers firms� cost of capital. The results show that credit access, used as a measure of firm-level financial access, has significant negative effect on the cost of capital. The results remain significant when credit access is instrumented with indicators of firms� political connections. Taking advantage of the large country coverage of the dataset, I also relate firms� cost of capital to country-level measures of financial development and find that financial development reduces the cost of capital. These findings confirm that financial access allows firms to employ more capital.

Date: July 2011 | Full Text