Does Access to Finance Lower Firms’ Cost of Capital? Empirical Evidence from International Manufacturing Data

Addisu Lashitew ()

No GD-120, GGDC Research Memorandum from Groningen Growth and Development Centre, University of Groningen

Abstract: Lack of access to finance is argued to be one of the most binding constraints for firm growth. There is, however, limited empirical evidence on the relationship between access to finance and the cost of capital. This paper uses international manufacturing data to analyze the effect of access to finance on firms? cost of capital. Using a unique dataset that covers tens of thousands firms in more than 80 countries, I examine the effect of credit access on firms? cost of capital. I address the endogeneity of credit access by instrumenting it with indicators of the strength of firms? political connections. The results show that credit access has significant negative effect on the cost of capital. Taking advantage of the large country coverage of the dataset, I also relate firms? cost of capital to country-level measures of financial development and find that financial development reduces cost of capital.

Date: 2011
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