Chan, Rosanna2014-03-182014-03-182014-03https://hdl.handle.net/10986/17300Financial constraints are widespread in developing countries, where even short-term credit is limited. Finance held by firms as working capital is a substantial proportion of sales revenue, yet the role of working capital is largely neglected by existing models of financial constraints. This paper presents a dynamic model of the firm that incorporates working capital by introducing a delay between factor payments and the receipt of revenue. In contrast with previous models, the working capital model predicts that firms under binding constraints will substitute between labor and capital in response to demand shocks, causing investment to be countercyclical. For firms near the margin of being constrained, constraints bind when positive production opportunities arise. Output growth is therefore constrained in response to positive shocks but not to negative shocks. Simulations suggest that models without working capital may understate the predicted effects of financial constraints on production efficiency, firm profit and growth over time. The predictions are tested with the Bangladesh Panel Survey data for manufacturing firms. Consistent with the theory, there is evidence that constraints bind when output price increases, that investment by constrained firms is countercyclical, and that output response to positive shocks is dampened for firms that are sometimes constrained. The results also are important for policy. In order to maximize growth, efforts to relieve credit constraints should be focused on periods when demand shocks are high.en-USCC BY 3.0 IGOACCELERATORACCESS TO CREDITACCESS TO EXTERNAL FINANCEACCESS TO FINANCEACCESS TO FINANCINGACCOUNTINGACCOUNTS RECEIVABLEAFFILIATED ORGANIZATIONSAGENCY COSTSAMOUNT OF CAPITALAVAILABILITY OF CREDITBANK LOANBANKING SECTORBANKING SECTOR ASSETSBASE YEARBINDING CONSTRAINTSBONDBONDSBORROWINGBORROWING REQUIREMENTSBUDGET CONSTRAINTBUSINESS CYCLEBUSINESS CYCLESCAPITAL ACCOUNTSCAPITAL ACCUMULATIONCAPITAL ASSETSCAPITAL CONSTRAINTSCAPITAL INFLOWSCAPITAL INVESTMENTCAPITAL MARKETSCAPITAL RATIOCAPITAL RATIOSCAPITAL REQUIREMENTSCAPITAL STOCKCASH FLOWCASH ON HANDCOLLATERALCOMMERCIAL BANKSCONSUMER SURPLUSCONTRACT ENFORCEMENTCORPORATE INVESTMENTCORRUPTIONCOST OF CAPITALCOST OF FINANCECOST OF FUNDSCREDIT AVAILABILITYCREDIT CONSTRAINED FIRMCREDIT CONSTRAINTSCREDIT MARKETCREDIT RATIONINGDEBTDECISION MAKINGDEVELOPING COUNTRIESDEVELOPING COUNTRYDEVELOPING ECONOMIESDEVELOPMENT POLICYDISINVESTMENTDIVIDENDDIVIDEND PAYMENTDURABLEECONOMETRICSECONOMIC ACTIVITYECONOMIC DEVELOPMENTECONOMIC GROWTHECONOMIC IMPLICATIONSECONOMIC RESEARCHEMERGING ECONOMIESENFORCEMENT MECHANISMSENTERPRISE DEVELOPMENTENTREPRENEURSEQUATIONSEQUIPMENTEXPECTED RETURNSEXTERNAL FINANCEFACTOR DEMANDFACTORS OF PRODUCTIONFARMERFINANCE ACCESSFINANCE CONSTRAINTSFINANCESFINANCIAL CONSTRAINTFINANCIAL CONSTRAINTSFINANCIAL DEVELOPMENTFINANCIAL FACTORSFINANCIAL INSTITUTIONSFINANCIAL INTERMEDIARYFINANCIAL MARKETSFINANCIAL NEEDSFINANCIAL POLICYFINANCIAL RESOURCESFINANCIAL SECTORFIRM GROWTHFIXED INPUTSFIXED INVESTMENTFOREIGN BANKSFOREIGN DIRECT INVESTMENTFOREIGN INFLOWSFOREIGN TRADEGDPGROWTH RATEHIGH INTEREST RATESHOLDINGHOLDINGSIDINCOMEINCOME EFFECTINEFFICIENCYINSTRUMENTINTEREST RATEINTEREST RATE SHOCKSINTEREST RATESINTERNAL FINANCEINTERNAL FUNDSINTERNATIONAL BANKINVENTORIESINVENTORYINVESTMENT BEHAVIORINVESTMENT CLIMATEINVESTMENT CLIMATE ASSESSMENTINVESTMENT OPPORTUNITIESINVESTMENT SPENDINGINVESTMENT-CASH FLOW SENSITIVITIESLIMITED ACCESSLIQUID ASSETLIQUID ASSETSLIQUIDITYLIQUIDITY CONSTRAINTLIQUIDITY CONSTRAINTSMACROECONOMICSMANUFACTURING INDUSTRIESMARGINAL COSTMARGINAL PRODUCTMARGINAL VALUEMARKET CAPITALIZATIONMARKET INTERESTMARKET INTEREST RATESMARKET PRICEMATURITYMICROENTERPRISESNEGATIVE SHOCKNEGATIVE SHOCKSNET WORTHOPPORTUNITY COSTOPTIMIZATIONPERMANENT SHOCKSPHYSICAL CAPITALPREPAYMENTPRICE CHANGESPRICE INCREASESPRICE TAKERSPRIVATE INVESTMENTPRIVATE SECTOR DEVELOPMENTPRODUCTION EFFICIENCYPRODUCTION FUNCTIONPRODUCTION INPUTSPROFIT MAXIMIZINGPROFIT OPPORTUNITYRATE OF GROWTHREAL INTERESTREAL INTEREST RATERECEIPTRECEIPTSRETURNSALES REVENUESAVINGSSECONDARY MARKETSSHORT TERM DEBTSOURCES OF FINANCESTOCK EXCHANGESSUBSTITUTION EFFECTSUPPLY SHOCKSTERM CREDITTERMS OF CAPITALTRADE CREDITTRADE LIBERALIZATIONTURNOVERVALUE OF OUTPUTVOLATILE ENVIRONMENTSVOLATILITYWAGESWEALTHWORKING CAPITAL10.1596/1813-9450-6797