1198 The Econometrics of Finance and Growth
address the different biases resulting from the standard OLS cross-country growth
regression, a fourth approach has used disaggregated firm and, more recently,
household-level data to assess the impact of access to financial services on firm
growth and household welfare. The advantage of using micro-level data is that it
allows more clearly the disentangling and testing of the mechanisms and channels
through which financial development enhances economic growth. A disadvan-
tage is that it focuses on the direct effect of finance on firm growth and household
welfare but commonly does not consider spillover effects on other firms and house-
holds and therefore does not allow for individual effects to be added up to an
aggregate growth effect.^32
Further, as in the case of cross-country regressions, biases due to omitted vari-
ables, measurement error and reverse causation have to be addressed. This section
discusses several studies using micro-data that assess whether easier access to
finance is associated with faster firm growth and higher household welfare. Unlike
the previous section, this section does not introduce new methodologies, but rather
discusses methodological challenges stemming from the use of micro-, as opposed
to country-level data.
25.6.1 Firm-level approaches
The different approaches discussed in this section consist of relating firm-level
growth or investment to country-level financial development measures. As in the
case of cross-country regressions, however, this implies controlling for biases stem-
ming from reverse causation and omitted variables. A first approach, suggested by
Demirgüç-Kunt and Maksimovic (1998), compares firm growth to an exogenously
given benchmark. Specifically, they calculate for each firm in an economy the rate
at which it can grow, using (i) only its internal funds or (ii) its internal funds and
short-term borrowing, based on the standard “percentage of sales” financial plan-
ning model (Higgins, 1977). Given a set of simplifying assumptions, the external
financing needsEFNat timetof a firm growing at rateg(t)is given by:^33
EFN(t)=g(t)∗Assets(t)−[ 1 −g(t)]∗Earnings(t)∗b(t), (25.24)whereb(t)is the fraction of the firm’s earnings that are retained for reinvestment at
timet. Assuming that the firm retains all its earnings, that is,b(t)=1, the internally
financed growth rateIG(t)is the maximum growth rate that can be financed with
internal resources only, that is:
IG(t)=ROA(t)/[ 1 −ROA(t)]. (25.25)Demirgüç-Kunt and Maksimovic (1998) then regress the percentage of firms in a
country that grow at rates exceedingIG(t)on financial development, other country
characteristics and averaged firm characteristics in a simple OLS set-up and show,
for a sample of 8,500 firms across 30 countries, that the proportion of firms growing
beyond the rate allowed by internal resources is higher in countries with better
developed banking systems and more liquid stock markets.^34