1. ESTUDIOS MONETARIOS Y FINANCIEROS THE IMPACT OF FINANCIAL VARIABLES ON FIRMS’ REAL DECISIONS: EVIDENCE FROM SPANISH FIRM-LEVEL DATA Ignacio Hernando Carmen Martínez-Carrascal WORKSHOP ON CORPORATE FINANCE AND MONETARY POLICY 15-16 May 2006

2. ESTUDIOS MONETARIOS Y FINANCIEROS 2 INTRODUCTION  Financial position of the corporate sector may influence the performance of the real economy and the stability of the financial system  In its turn, the financial position of the corporate sector is relevant to determine the magnitude of the effects of monetary policy shocks  Adjustment by companies as a result of monetary policy shift can potentially involve a wide range of activities, but their response might depend on the degree of financial pressure they face  Distribution of financial position matters. Financial fragility of certain firms are not offset by soundness of others. The effect of aggregate financial indicators on business activity in estimates at macro level has been elusive.  Aim of this paper: describing aspects of the financial situation of the corporate sector in Spain and analyzing how companies adjust investment and employment to variations in financial pressure

3. ESTUDIOS MONETARIOS Y FINANCIEROS 3 KEY ISSUES OF THE PAPER  Overall picture of the financial position of Spanish non-financial firms - Substantial cross-sectional dispersion in terms of the degree of financial tightness II. The impact of financial position on business activity. - Financial position, proxied by alternative financial variables, matters for business activity III. Shape of the relationship - The impact is non-linear and becomes more intense when financial pressure exceeds a certain threshold IV. Construction of composite indicators for the impact of corporate financial health on real decisions - Indicators based on aggregate data may not be reliable enough to capture the impact of corporate financial health on real decisions

4. ESTUDIOS MONETARIOS Y FINANCIEROS 4 I. DESCRIPTIVE ANALYSIS OF FIRMS’ FINANCIAL POSITION (I)  Data: Unbalanced panel of around 9,000 non-financial companies over the 1985-2001 period (Central Balance Sheet Data Office)  Financial variables considered: – Indebtedness: – Corporate profitability – Debt burden

5. ESTUDIOS MONETARIOS Y FINANCIEROS 5 I. DESCRIPTIVE ANALYSIS OF FIRMS’ FINANCIAL POSITION (II)  Substantial cross-sectional variation in the distribution of Spanish firms for indebtedness, profitability and debt burden indicators

6. ESTUDIOS MONETARIOS Y FINANCIEROS 6 I. DESCRIPTIVE ANALYSIS OF FIRMS’ FINANCIAL POSITION (III)

7. ESTUDIOS MONETARIOS Y FINANCIEROS 7 KEY ISSUES OF THE PAPER I. Overall picture of the financial position of Spanish non-financial companies. Cross-sectional dispersion II. The impact of financial position on business activity. Relative importance of alternative financial variables III. This impact is non-linear and becomes more intense when financial pressure exceeds a certain threshold IV. Construction of composite indicators for the impact of corporate financial health on real decisions

8. ESTUDIOS MONETARIOS Y FINANCIEROS 8 II. THE IMPACT OF FINANCIAL POSITION ON INVESTMENT AND EMPLOYMENT DECISIONS  Estimation method: System- GMM

9. ESTUDIOS MONETARIOS Y FINANCIEROS 9 II. THE IMPACT OF FINANCIAL POSITION ON INVESTMENT AND EMPLOYMENT DECISIONS. EMPIRICAL RESULTS  When included one at a time, all financial indicators are significant  When simultaneously included, the indicators of debt-service burden are those that display a more robust effect  Preferred specifications: –Investment: total debt burden, gross revenue over total assets and net debt over total assets –Employment: total debt burden and gross revenue over total assets

10. ESTUDIOS MONETARIOS Y FINANCIEROS 10 KEY ISSUES OF THE PAPER I. Overall picture of the financial position of Spanish non-financial companies. Cross-sectional dispersion II. The impact of financial position on business activity. Relative importance of alternative financial variables III. This impact is non-linear and becomes more intense when financial pressure exceeds a certain threshold IV. Construction of composite indicators for the impact of corporate financial health on real decisions

11. ESTUDIOS MONETARIOS Y FINANCIEROS 11 III. a. NON-LINEAR LINK BETWEEN FINANCIAL POSITION AND INVESTMENT. DESCRIPTIVE EVIDENCE

12. ESTUDIOS MONETARIOS Y FINANCIEROS 12 III. b. NON-LINEAR LINK BETWEEN FINANCIAL POSITION AND EMPLOYMENT. DESCRIPTIVE EVIDENCE

13. ESTUDIOS MONETARIOS Y FINANCIEROS 13 III. c. NON-LINEAR LINK BETWEEN FINANCIAL POSITION AND INVESTMENT. EMPIRICAL RESULTS

14. ESTUDIOS MONETARIOS Y FINANCIEROS 14 KEY ISSUES OF THE PAPER I. Overall picture of the financial position of Spanish non-financial companies. Cross-sectional dispersion II. The impact of financial position on business activity. Relative importance of alternative financial variables III. This impact is non-linear and becomes more intense when financial pressure exceeds a certain threshold IV. Construction of composite indicators for the impact of corporate financial health on real decisions

15. ESTUDIOS MONETARIOS Y FINANCIEROS 15 IV. COMPOSITE INDICATOR OF THE IMPACT OF FINANCIAL CONDITIONS ON INVESTMENT AND EMPLOYMENT  This indicator must take into account the following elements: –Cross-sectional dispersion in firms’ financial position –Differences across firms in the sensitivity of their real decisions to their financial position –Relative weight of each firm for the evolution of aggregate investment  Our preferred non-linear specifications include: – total debt-burden, net debt and gross revenue (investment) – total debt-burden and gross revenue (employment)

16. ESTUDIOS MONETARIOS Y FINANCIEROS 16 IV. COMPOSITE INDICATOR OF THE IMPACT OF FINANCIAL CONDITIONS ON INVESTMENT

17. ESTUDIOS MONETARIOS Y FINANCIEROS 17 IV. COMPOSITE INDICATOR OF THE IMPACT OF FINANCIAL CONDITIONS ON EMPLOYMENT

18. ESTUDIOS MONETARIOS Y FINANCIEROS 18 V. USES OF COMPOSITE INDICATORS OF THE IMPACT OF FINANCIAL CONDITIONS ON EMPLOYMENT AND INVESTMENT (I)  Regularly analyzed to assess investment prospects –Updated using CBSO (annual and quarterly) data Annual CBSO data: available with an approximate lag of 1 year. Quarterly CBSO data: available with a lag of 1 quarter The annual database contains approximately 8000 firms per year. The quarterly database contains on average 900 firms per quarter Large companies have a predominant weight

19. ESTUDIOS MONETARIOS Y FINANCIEROS 19 V. USES OF COMPOSITE INDICATORS OF THE IMPACT OF FINANCIAL CONDITIONS ON EMPLOYMENT AND INVESTMENT (I)  Regularly analyzed to assess investment prospects

20. ESTUDIOS MONETARIOS Y FINANCIEROS 20 V. USES OF COMPOSITE INDICATORS OF THE IMPACT OF FINANCIAL CONDITIONS ON EMPLOYMENT AND INVESTMENT (II)  Explanatory power to explain aggregate productive investment growth rate, using the quarterly macroeconometric model of the Spanish economy  The introduction of composite indicator results in a reduction of the non- explained component. The contribution of the rest of the variables remains broadly unchanged

21. ESTUDIOS MONETARIOS Y FINANCIEROS 21 KEY FINDINGS  Substantial cross-sectional dispersion in terms of the degree of financial tightness  Financial position matters for business activity  This link is non-linear and becomes more intense when financial pressure exceeds a certain threshold  Indicators based on aggregate data are not reliable enough to capture the impact of corporate financial health on real decisions

22. ESTUDIOS MONETARIOS Y FINANCIEROS THANK YOU FOR YOUR ATTENTION