Financial Frictions, Investment, and Institutions

Financial frictions have been identified as key factors affecting economic fluctuations and growth. But, can institutional reforms reduce financial frictions? Based on a canonical investment model, we consider two potential channels: (i) financial transaction costs at the firm level; and (ii) required return at the country level. We empirically investigate the effects of institutions on these financial frictions using a panel of 75,000 firm-years across 48 countries for the period 1990 - 2007. We find that improved corporate governance (e.g., less informational problems) and enhanced contractual enforcement reduce financial frictions, while stronger creditor rights (e.g., lower collateral constraints) are less important.
Publication date: October 2010
ISBN: 9781455209316
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Finance , Financial Friction , institution , creditor rights , measurement errors , correlation , equation , financial markets , standard deviation , Corporate Finance and Governance: General , Economic Growth and Aggregate Productivity: General

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