1. Financial Development & Corporate Growth IN DIRECT INTERSECTORAL COMPARISONS Jan Bena and Štěpán Jurajda LSE and CERGE-EI LSE November, 2006

2. MOTIVATION There is positive cross-country correlation between financial development and economic activity (Goldsmith, 1969; King & Levine, 1993). Size of finance-growth effect? Finance-growth effect on particular firm types? But how can we disentangle two-way causality? –Supply → Firms need external finance to reap growth opportunities. –Demand ← Financial development reflects future growth opportunities. –Growth opportunities are unobservable. –No episodes of exogenous changes in financial development. –Identification relies on strong assumptions.

3. DEALING WITH REVERSE CAUSALITY: Literature Cross-country studies –Initial period indicators of country financial development (King and Levine, 1993; Levine and Zervos, 1998) –Instrumental variables, mostly legal origin (La Porta et al., 1998; Levine et al., 2000) Regional differences within a single country –Controls for unobservable country-level growth determinants (Jayarante and Strahan, 1996; Bertrand et al., 2004) Experience of specific industries across countries –Quantify industry need of external finance (Rajan and Zingales, 1998; Beck et al., 2004; Guiso et al., 2004)

4. THE RAJAN-ZINGALES STRATEGY: Assumptions (A1) Industry growth opportunity shocks are global = the same need to expand production (A2) Industry technology is also constant across countries = the same $ of external finance to expand production by a unit → Cross-industry differences in the need for external finance are the same across countries. (A3) U.S. listed firms face a perfectly elastic supply of external finance. → Observed industry external finance dependence in the U.S. (US_EFD) serves as counterfactual for outside financing need in other countries.

5. THE RAJAN-ZINGALES STRATEGY: Implementation Regress industry growth on –country and global industry fixed effects –interaction term US_EFD INDUSTRY * Financial_Development COUNTRY to ask whether industries more dependent on outside finance grow faster in financially more developed countries. STRONG: Reverse causality endogeneity at country level. WEAK: Constant industry differences in demand for external finance across countries such as U.S., Finland, Philippines, Zimbabwe,... –Direct tests of assumptions are not available. –Similarity of technological content of industries across development levels threatened by empirical trade research (Schott, 2003).

6. AN ALTERNATIVE STRATEGY: Assumptions (A1) Industry growth opportunity shocks are global. (A4) Corporate growth in a given industry would be the same in absence of differences in country financial development. + Apply both assumptions in a more appropriate context: EU-15 ‘single market’,1995-2003 (harmonized product market regulation) Industry growth is verifiably highly synchronized Comparable firms: Age, Size, Leverage, Tangibility, Quoted, Ownership,... → Do two comparable EU-15 firms in the same industry but facing different financial system grow at different rates?

7. AN ALTERNATIVE STRATEGY: Cost and Benefits Benefits of (A4) – Avoid quantification of industry EFD – Obtain economically measurable estimates Costs of (A4) – Heterogeneity in financial development in EU-15 assumed orthogonal to other country-level determinants affecting growth. → Control for initial-period GDP to capture ‘convergence’ effects. – Use initial-period (predetermined) indicators of country financial development. What if markets are forward looking? → Control for country-level future growth opportunities

8. BASIC SPECIFICATION G ijkt = α + βFD i + γGDP i + δ tj + X k ′ζ + ε ijkt G ijkt Annual growth rate of firm k in industry j in country i in year t during 1995-2003. FD i Financial development indicators: Private credit, Stock market capitalization, Total capitalization, Stock market value traded, Accounting standards, Control premium, 1990-1994 average. δ tj Industry-year dummies, corresponding to synchronized time path of industry growth across the EU-15. XkXk Firm-specific initial-period characteristics: Age, Size, Leverage, Tangibility, Collateral, Legal form, Quotation, Ownership,... GDP i Real GDP per capita in 1990.

9. DATA Firm level: Amadeus ‘TOP 250 thousand’ for EU-15 – Real value-added growth of manufacturing firms – Only public and private limited liability companies – Remove state-owned firms – Best firm-level EU data source available to date Country financial development indicators – World Bank Financial Structure and Economic Development Database – Total capitalization: Includes debt securities (Hartmann et al., 2006) – Control premium: Private benefits of control (Dyck & Zingales, 2004) Industry level: OECD STAN – Industry growth rates used to identify synchronized industries.

10. CORPORATE DESCRIPTIVE STATISTICS: Firm-Year Data over 1995-2003 SizeGrowthAgeLeverage N Quoted N MeanMedianMeanMedianMeanMedianMeanMedian Austria 81.341.70.0500.04118.911.00.510.53 28942 Belgium 47.215.90.0230.01422.617.00.630.66 1459,792 Denmark 52.120.70.0770.07526.819.00.560.58 43777 Finland 48.214.80.0480.04020.210.00.540.55 2483,666 France 59.519.80.0290.01929.923.00.540.55 46310,768 Germany 125.648.80.0390.03029.216.00.480.47 6404,309 Greece 24.610.30.0660.05616.313.00.580.59 1,0045,470 Italy 39.718.40.0350.02520.817.00.59 30634,042 Netherlands 53.726.90.0140.00835.928.00.52 01,138 Portugal 38.817.80.0100.00027.722.00.590.61 821,452 Spain 40.217.00.0610.05121.318.00.590.61 33618,596 Sweden 39.612.00.0540.05034.129.00.490.48 474,707 UK 62.920.10.0690.06629.021.00.630.65 5014,971

11. FINANCIAL DEVELOPMENT: The EU-15 over 1990-1994 Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Mean 0.820.301.350.1363.60.12 Median 0.850.231.450.0962.00.07 S.D. / Mean 0.400.770.330.900.191.15 Min 0.320.100.510.0336.00.01 Max 1.410.972.250.4583.00.38 Min CountryGreeceAustriaGreece PortugalUK Max CountryNetherlandsUK SwedenAustria N13 1213 11

12. FINANCIAL DEVELOPMENT AND CORPORATE GROWTH: Basic Estimates Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Financial Development 0.028***0.032***0.020***0.067***0.121***0.020*** (0.009)(0.004) (0.007)(0.025)(0.005) Age-0.050*** -0.051*** -0.050***-0.049*** (0.007) (0.008)(0.007) Size-0.117*** -0.119***-0.121***-0.113***-0.119*** (0.024)(0.025) (0.023)(0.026)(0.027) Leverage0.065***0.059***0.060***0.061***0.064***0.068*** (0.012)(0.014) (0.013)(0.012)(0.013) Tangibility0.020***0.019***0.018**0.019***0.020***0.020** (0.006) (0.007)(0.006) (0.008) Collateralization-0.032*-0.030*-0.03-0.028-0.031*-0.033* (0.016)(0.017) (0.016)(0.018) Quoted0.016*** 0.014***0.016***0.013* (0.004) (0.006) Private Limited Company 0.012***0.011***0.013***0.009***0.010***0.013*** (0.003) (0.002) (0.004) Real GDP-4.777***-4.665***-5.752***-4.619***-5.184***-4.285*** (0.603)(0.930)(0.761)(0.864)(0.465)(1.150) N109,500 108,741109,500109,49894,497 R2R2 0.15

13. FINANCIAL DEVELOPMENT AND CORPORATE GROWTH: Basic Estimates Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Financial Development 3.1%2.8%3.5%2.8%5.7% (0.009)(0.004) (0.007)(0.025)(0.005) Age-0.050*** -0.051*** -0.050***-0.049*** (0.007) (0.008)(0.007) Size-0.117*** -0.119***-0.121***-0.113***-0.119*** (0.024)(0.025) (0.023)(0.026)(0.027) Leverage0.065***0.059***0.060***0.061***0.064***0.068*** (0.012)(0.014) (0.013)(0.012)(0.013) Tangibility0.020***0.019***0.018**0.019***0.020***0.020** (0.006) (0.007)(0.006) (0.008) Collateralization-0.032*-0.030*-0.03-0.028-0.031*-0.033* (0.016)(0.017) (0.016)(0.018) Quoted0.016*** 0.014***0.016***0.013* (0.004) (0.006) Private Limited Company 0.012***0.011***0.013***0.009***0.010***0.013*** (0.003) (0.002) (0.004) Real GDP-4.777***-4.665***-5.752***-4.619***-5.184***-4.285*** (0.603)(0.930)(0.761)(0.864)(0.465)(1.150) N109,500 108,741109,500109,49894,497 R2R2 0.15

14. FOCUS ON SYNCHRONIZED INDUSTRIES Our strategy is based on (A1) synchronization of industry growth shocks, so it will fail where industry growth is driven by local regulation. Hence, we identify synchronized industries using ANOVAs of industry growth with YEAR and COUNTRY factors. Synchronization corresponds to strong YEAR factors. – Differentiate Low-, Medium-, and High-synchronization industry groups. – Or use continuous synchronization measure.

15. DEVELOPMENT AND GROWTH: Industry Synchronization Groups Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Low-synchronization based on ANOVA: Year factor WEAK Financial Development 0.017 0.0090.0390.087**0.001 (0.015)(0.010)(0.008)(0.024)(0.035)(0.007) N6,896 6,8326,896 6,498 R2R2 0.12 Medium-synchronization based on ANOVA: Year factor STRONG; Country factor STRONG Financial Development 0.031***0.035***0.023***0.073***0.141***0.024*** (0.009)(0.004)(0.005)(0.006)(0.028)(0.006) N59,310 58,92759,31059,30949,447 R2R2 0.16 0.15 High-synchronization based on ANOVA: Year factor STRONG; Country factor WEAK Financial Development 0.028***0.030***0.019***0.063***0.097***0.018*** (0.008)(0.003) (0.005)(0.023)(0.004) N43,294 42,98243,29443,29338,552 R2R2 0.14

16. FIRM-TYPE INTERACTIONS G ijkt = α + β 0 FD i + β 1 x k ⋅ FD i + γGDP i + δ tj + X k ′ζ + ε ijkt xkxk A firm-specific initial-period characteristic: AgeYears from incorporation SizePercentage deviation from industry median firm size TangibilityFixed assets over Total assets Collateralization(Fixed assets + Inventories + Receivables) / Total Assets

17. AGE Interaction Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Full Sample Financial Development0.015***0.025***0.010***0.053***0.082***0.016*** (0.004) (0.002)(0.008)(0.013)(0.003) Financial Development × Age 0.054***0.027***0.043***0.057***0.150***0.016** (0.011)(0.009)(0.006)(0.019)(0.032)(0.008) Age-0.097***-0.061***-0.117***-0.061***-0.152***-0.056*** (0.010)(0.004)(0.010)(0.004)(0.022)(0.005) N109,500 108,741109,500109,49894,497 Young Firms (Below Median Age) Financial Development0.0080.0100.0020.028*0.0330.000 (0.009)(0.008)(0.005)(0.015)(0.027)(0.006) Financial Development × Age 0.199**0.260***0.185***0.506***0.763***0.227*** (0.079)(0.075)(0.044)(0.151)(0.255)(0.060) Age-0.283***-0.214***-0.372***-0.200***-0.635***-0.225*** (0.062)(0.029)(0.060)(0.026)(0.167)(0.028) N53,552 53,20253,552 45,491 Old Firms (Above Median Age) Financial Development 0.029***0.032***0.018***0.061***0.139***0.019*** (0.007) (0.004)(0.014)(0.023)(0.005) Financial Development × Age 0.0040.010.018**0.0220.003 (0.015)(0.014)(0.009)(0.028)(0.045)(0.011) Age-0.041***-0.040***-0.065***-0.041***-0.039-0.037*** (0.014)(0.006)(0.014)(0.006)(0.030)(0.006) N53,530 53,13953,53053,52846,844

18. SIZE Interaction Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Full Sample Financial Development0.027***0.032***0.019***0.067***0.121***0.020*** (0.003) (0.002)(0.006)(0.009)(0.002) Financial Development × Size 0.108*-0.0170.055*-0.0020.002-0.010 (0.060)(0.045)(0.032)(0.090)(0.173)(0.039) Size-0.209***-0.110***-0.205***-0.121***-0.115-0.114*** (0.053)(0.022)(0.051)(0.021)(0.118)(0.023) N109,500 108,741109,500109,49894,497 Young Firms (Below Median Age) Financial Development0.024***0.031***0.016***0.068***0.097***0.019*** (0.005)(0.004)(0.003)(0.009)(0.015)(0.004) Financial Development × Size 0.114-0.0140.0650.025-0.073-0.004 (0.102)(0.075)(0.056)(0.144)(0.289)(0.065) Size-0.300***-0200***-0.305***-0.214***-0.154-0.205*** (0.089)(0.035)(0.091)(0.033)(0.193)(0.038) N53,552 53,20253,552 45,491 Old Firms (Above Median Age) Financial Development 0.032***0.038***0.025***0.074***0.146***0.022*** (0.004) (0.002)(0.008)(0.012)(0.003) Financial Development × Size -0.059-0.077-0.028-0.146-0.290-0.055 (0.072)(0.056)(0.038)(0.115)(0.210)(0.048) Size0.013-0.0080.003-0.0160.162-0.021 (0.065)(0.028)(0.062)(0.027)(0.144)(0.030) N53,530 53,13953,53053,52846,844

19. COLLATERALIZATION Interaction Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Full Sample Financial Development-0.023-0.017-0.017**-0.040-0.060-0.017* (0.014)(0.012)(0.008)(0.024)(0.045)(0.010) Financial Development × Collat. 0.060***0.061***0.045***0.132***0.215***0.046*** (0.017)(0.014)(0.009)(0.029)(0.052)(0.012) Collateral-0.081***-0.052***-0.094***-0.050***-0.175***-0.051*** (0.014)(0.007)(0.014)(0.007)(0.035)(0.007) N109,500 108,741109,500109,49894,497 Young Firms (Below Median Age) Financial Development-0.061***-0.037*-0.035***-0.076*-0.146**-0.041** (0.022)(0.020)(0.013)(0.039)(0.070)(0.016) Financial Development × Collat. 0.103***0.083***0.063***0.177***0.291***0.074*** (0.025)(0.023)(0.015)(0.046)(0.082)(0.019) Collateral -0.113***-0.060***-0.120***-0.056***-0.226***-0.060*** (0.020)(0.010)(0.021)(0.009)(0.054)(0.009) N53,552 53,20253,552 45,491 Old Firms (Above Median Age) Financial Development -0.041**-0.018-0.014-0.028-0.139**-0.016 (0.020)(0.019)(0.012)(0.038)(0.067)(0.015) Financial Development × Collat. 0.084***0.066***0.043***0.146***0.292***0.045** (0.023)(0.022)(0.014)(0.043)(0.076)(0.018) Collateral -0.098***-0.053***-0.091***-0.051***-0.226***-0.045*** (0.019)(0.010)(0.020)(0.009)(0.051)(0.009) N55,275 54,94255,27555,27446,348

20. TANGIBILITY Interaction Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Full Sample Financial Development0.028***0.029***0.017***0.066***0.129***0.016*** (0.006)(0.005)(0.003)(0.011)(0.019)(0.004) Financial Development × Tangib. 0.0000.0080.0090.003-0.0210.012 (0.013)(0.012)(0.007)(0.023)(0.040)(0.010) Tangibility0.020*0.016***0.0060.019***0.0330.015*** (0.011)(0.005)(0.011)(0.005)(0.027)(0.006) N109,500 108,741109,500109,49894,497 Young Firms (Below Median Age) Financial Development0.023***0.026***0.014***0.062***0.105***0.011* (0.008) (0.005)(0.017)(0.029)(0.006) Financial Development × Tangib. 0.0040.0140.0080.018-0.0220.024 (0.020)(0.019)(0.011)(0.037)(0.065)(0.015) Tangibility 0.0180.015*0.0090.018**0.0350.012 (0.016)(0.008)(0.016)(0.007)(0.043)(0.008) N53,552 53,20253,552 45,491 Old Firms (Above Median Age) Financial Development 0.038***0.040***0.025***0.085***0.174***0.021*** (0.007) (0.004)(0.014)(0.024)(0.005) Financial Development × Tangib. -0.022-0.010-0.001-0.038-0.083*-0.003 (0.017)(0.015)(0.010)(0.030)(0.050)(0.012) Tangibility 0.032**0.015**0.0120.018***0.068**0.014* (0.015)(0.007)(0.015)(0.007)(0.033)(0.008) N53,530 53,13953,53053,52846,844

21. ROBUSTNESS CHECKS Financial development measures misleading – if they reflect not only differences in available supply of finance, – but also demand for finance driven by future country growth opportunities. → Control for predicted future country growth: Take industry averages of EU-15 realized growth over 1995-2003, and weight them by initial-period country-level shares of each industry. Robustness to removing UK and Greece Median Regressions

22. Robustness to AGGREGATE GROWTH OPPORTUNITIES Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Financial Development 0.0180.027***0.016***0.058***0.110***0.020*** (0.012)(0.004)(0.005)(0.007)(0.032)(0.004) Growth Opportunities4.2064.965**4.699**4.808**1.4748.614*** (2.954)(1.770)(1.812)(1.709)(2.340)(2.523) Age-0.050***-0.051*** -0.052***-0.050***-0.051*** (0.007) Size-0.118***-0.117***-0.119***-0.121***-0.114***-0.118*** (0.024)(0.025) (0.023)(0.026) Leverage0.065***0.060***0.061*** 0.064***0.069*** (0.012)(0.013) (0.012)(0.013) Tangibility0.020***0.018**0.017**0.019**0.019***0.019** (0.006) (0.007)(0.006) (0.007) Collateralization-0.032*-0.030*-0.030-0.028-0.031*-0.031 (0.016)(0.017) (0.016)(0.018) Quoted0.017***0.018***0.017***0.016*** 0.012** (0.004)(0.003)(0.004) (0.005) Private Limited Company 0.012***0.010***0.011***0.008***0.010***0.009*** (0.003)(0.002) Real GDP-5.231***-5.314***-6.199***-5.253***-5.323***-4.339*** (0.526)(0.636)(0.634)(0.511)(0.391)(0.647) N109,500 108,741109,500109,49894,497 R2R2 0.15

23. Robustness to Removing UNITED KINGDOM and GREECE Private Bank Credit Market Capitalization Total Capitalization Market Value Traded Accounting Standards Control Premium Basic Estimates Financial Development 0.028***0.032***0.020***0.067***0.121***0.020*** (0.009)(0.004) (0.007)(0.025)(0.005) N109,500 108,741109,500109,49894,497 R2R2 0.15 Robustness to Removing United Kingdom Financial Development 0.017**0.0250.012*0.0450.089***0.010 (0.006)(0.023)(0.006)(0.051)(0.025)(0.006) N94,529 93,77094,52994,52779,526 R2R2 0.18 Robustness to Removing Greece Financial Development 0.028**0.031***0.020***0.065***0.117***0.020*** (0.012)(0.004)(0.005)(0.007)(0.026)(0.005) N104,278 103,519104,278104,27694,497 R2R2 0.15

24. CONCLUSIONS We apply simple cross-country comparisons in an appropriate setting: – within EU-15, – to synchronized industries, – to many similar firms, both large and small. As a result, we obtain – coefficients that translate to easy-to-interpret magnitudes, – differences in the finance-growth effect by firm types. Findings: – Move from the least to the most developed financial system within the EU-15 boosts firm annual growth rate by 2 to 3 percentage points. – Young firms have limited access to financial markets. – Ability to provide collateral helps to get outside finance, especially if the firm is small or young. –We do not find a size effect interaction.