French Manufacturing Firms and the Capital Gap Since 1985 : A Credit Rationing Approach

What is it about?

Since the slowdown in the economy that began in 1990, research has shown that firms? sensitivity to changes in the economic climate varies according to their size. This is the main conclusion that can be drawn from the studies of the productive sector published annually by the Banque de France, and from the study by Augory, Avouy-Dovi, Busque and Queron (1996) of trends in the macroeconomic situation of small and medium-sized industrial firms between 1985 and 1992. Two sets of arguments may be advanced to explain the particular sensitivity of small and medium-sized industrial firms. The first is based on real determinants: firms of this type are more sensitive to cyclical shifts because their productive structures have less inertia and are therefore more flexible. The second is based on financial determinants, within which two particular approaches can be identified. * Researchers seeking to identify the existence of a credit channel emphasize the special position of small and medium-sized enterprises (Gertler, Gilchrist, 1993, 1994; Hubbard, 1995). According to this view, SMEs bear the brunt of real or monetary shocks affecting the economy because capital markets operate imperfectly. This research reveals the emergence of a flight to quality, reflected by a reduction in the amount of bank lending to SMEs (Oliner, Rudebusch, 1995). However, researchers have not managed to identify whether this effect is due to changes in the behaviour of lenders or of borrowers. * Researchers focusing specifically on SMEs point to the existence of a small business capital gap, generally identified by two features (Garvin, 1971). First, the cost of access to capital is higher for small businesses. Bardos (1991) has found this to be the case for small French firms on the credit market. Second, small businesses are reputed to suffer from a chronic shortage of long-term capital, whether in the form of share issues or bank loans. The corollary to this is high levels of short-term debt, which may explain why small businesses are more sensitive to economic shocks. Tamari (1980) shows that this is a permanent feature of the economic landscape of all the industrialized countries. Research carried out by the Banque de France has underlined the importance of short-term debt for small businesses (Beau, 1991; Boissonade, Tournier, 1996). An analysis of firms? capital structure according to size over the period 1990-1993 revealed significant differences in financial behaviour, especially once the payroll rose above 2,000 (Cieply, Paranque, 1996). Firms with less than 2,000 employees carried more debt. Among these firms, which are highly sensitive to the cost of borrowing, cash flow was a more important factor in obtaining loans. Likewise, as debt is the sole source of capital, small firms (unlike large firms) are not able to compensate for an increase in the working capital requirement or a fall in turnover by borrowing more. Moreover, as their accumulation rate tends to be higher than that of large firms, their financing requirements are correspondingly greater (Paranque, 1994, 1996). These features have led some economists and politicians to argue that the financial system is biased against small businesses and to justify the existence of financial institutions that specialize in lending to them . To the best of our knowledge, however, no research has yet shown that supply effects predominate over demand effects in determining the financial characteristics of firms in general and small businesses in particular. It is this question that we seek to address in this study, based on accounting and tax data collected by the Banque de France?s Balance Sheet Data Centre . An earlier study (Cieply, Paranque, 1996) revealed the existence of a size effect in the determination of the financial structures of French firms over the period 1990-1993. However, this effect only appeared clearly above the 2000 employee threshold and was not sufficient to identify the dominant factors explaining the financial structures observed. We therefore turned to a model that included the determinants of the demand for and supply of financial debt. The main findings of this research are: - the importance of credit rationing by demand over the period as a whole and across the population of firms; - the absence of any effect of substitution of debt to suppliers for debt to financial institutions, perhaps due to a lack of information about the customers of firms subject to credit rationing by supply; - the high frequency of firms with financial links subject to credit rationing by supply, which doubtless corresponds to specific methods for managing cash balances and the production cycle; - the fact that listed firms are more often in equilibrium than other firms. The hypothesis of a small business capital gap is borne out only for the smallest businesses, especially as regards long-term debt. However, this finding is not entirely clear-cut. We have sought here to construct notional supply of and demand for credit. We have no information about either lenders' offer of credit to firms, or about firms' real demand for credit. It may be that the real values are in fact different from the notional values. Firms may ration themselves in view of their own expectations of growth on their markets and their perception of the financial and monetary environment. They may already have screened their investment projects and defined a strategy likely to allow them to assume the solvency constraint and meet the standards of financial independence. Lastly, the prevalence of each configuration seems to depend more on the movement of interest rates than on their spread.

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