Yishay Yafeh, Mr. Kenichi Ueda, and Mr. Stijn Claessens
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.
Over the last two decades, cash holdings in nonfinancial firms around the world have increased. This phenomenon is particularly concerning in Japan, where the success of Abenomics depends on a transition from stimulus-driven to self-sustaining growth based on private consumption and investment. This paper finds that Japanese nonfinancial firms have accumulated cash at the expense of investment and dividends, hampering this transition. The evidence suggests that cash accumulation is due to financial imperfections combined with rising corporate profitability and uncertainty, while corporate governance plays only a limited role. These firms have cash holdings available for investment of about 5 percent of GDP. Policy options for encouraging the use of these cash holdings include improving firms’ access to market-based financing and discouraging CEO duality.