We propose the use of stochastic frontier approach to modelling financial constraints of firms. The main advantage of the stochastic frontier approach over the stylised approaches that use pooled OLS or fixed effects panel regression models is that we can not only decide whether or not the average firm is financially constrained, but also estimate a measure of the degree of the constraint for each firm and for each time period, and also the marginal impact of firm characteristics on this measure. We then apply the stochastic frontier approach to a panel of Indian manufacturing firms, for the 1997–2006 period. In our application, we highlight and discuss the aforementioned advantages, while also demonstrating that the stochastic frontier approach generates regression estimates that are consistent with the stylised intuition found in the literature on financial constraint and the wider literature on the Indian credit/capital market.
Bibliographical noteNOTICE: this is the author’s version of a work that was accepted for publication in Journal of banking and finance. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Bhaumik, S., Das, P., & Kumbhakar, S. A stochastic frontier approach to modelling financial constraints in firms: an application to India. Journal of banking and finance, vol.36 no.5 (2012) DOI http://dx.doi.org/10.1016/j.jbankfin.2011.11.026
Erratum: Bhaumik, SK, Das, PK & Kumbhakar, SC 2013, 'Erratum to: "A stochastic frontier approach to modelling financial constraints in firms: An application to India" [J. Bank. Finance 36 (2012) 1311-1319]' Journal of banking and finance, vol 37, no. 12, pp. 5159., 10.1016/j.jbankfin.2013.07.033
- firm investment
- stochastic frontier analysis
- financial constraint