Financial Sector Assessment a handbook, Chapter 4 Assessing Financial Structure and Financial Development, imf and World Bank, August 2005

Box 4.6 Use of Research-Based Micromodels—Liquidity Constraints in Capital Formation
Several research-based exercises carried out as back-
ground for recent financial sector assessment pro-
grams (FSAPs) have assessed financing conditions 
using firm-level data for nonfinancial firms. In a world 
without financially constrained firms, investment and 
financing decisions are independent from each other. 
However, the investment decisions of financially 
constrained firms often depend on the availability of 
cash flow (compare to Fazzari, Hubbard, and Petersen 
1988).
For the recent Mexican FSAP accounting data for 
73 nonfinancial-listed Mexican firms were drawn from 
WorldScope, a commercial data provider. The exer-
cise estimated the extent to which firm investment 
depended on cash flow rather than on the marginal 
profitability of capital. Although WorldScope tends 
to include only larger firms, it may be assumed that 
smaller firms are at least as financially constrained. 
Regressing investment ratios on marginal profit-
ability, financial leverage, and cash flow found cash 
flow to be a statistically significant variable, which 
can be evidence of Mexican firms being cash-flow 
constrained. In principle—given sufficient data—the 
exercise could be divided by class, size, or geographi-
cal region of firm. 
A similar exercise carried out for the Czech FSAP 
found that firms operating in the utilities, construc-
tion, and trading industries invested significantly 
more than other nonfinancial firms. If the firms are 
listed and the stock market is sufficiently liquid, mar-
ginal accounting profitability can be substituted by 
Tobin’s q-ratio. These kinds of data can throw addi-
tional light on firms’ financing characteristics. For 
instance in the Czech FSAP, it was found that trade 
credit was generally not used as a financing source 
for investment and that firms that were able to 
attract new bank loans used them, to a large extent, 
for purposes other than investment, for example, 
to repay old loans. The results suggested that the 
general reduction in the supply of bank credit during 
1999 may have increased the financing constraints 
of firms, especially those of small and highly lever-
aged firms.
Sources: Financial System Stability Assessments (FSSAs) for Czech Republic and Mexico, respectively.

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Financial Sector Assessment: A Handbook