Corporate Resilience To Banking Crises: The Roles Of Trust And Trade Credit
UC Berkeley; National Bureau of Economic Research (NBER)
The University of Hong Kong – Faculty of Business and Economics
Warren Buffett’s 2018 Activist Investment
Chinese University of Hong Kong – Business School, Department of Finance
March 16, 2016
Are firms more resilient to systemic banking crises in economies with higher levels of social trust? Using firm-level data in 34 countries from 1990 through 2011, we find that liquidity-dependent firms in high-trust countries obtain more trade credit and suffer smaller drops in profits and employment during banking crises than similar firms in low-trust economies. The results are consistent with the view that when banking crises block the normal banking-lending channel, greater social trust facilitates access to informal finance, cushioning the effects of these crises on corporate profits and employment.
Corporate Resilience To Banking Crises: The Roles Of Trust And Trade Credit – Introduction
Systemic banking crises are costly, common, and heavily researched. Boyd, Kwak, and Smith (2005), Kroszner, Laeven, and Klingebiel (2007), Claessens, Tong, and Wei (2012), and others show that banking crises shrink output and employment. Reinhardt and Rogoff (2009) document the ubiquitousness of financial crises throughout history, and Laeven and Valencia (2012) find that most countries experienced a systemic banking crisis between 1970 and 2011. Unsurprisingly, therefore, an enormous literature examines the causes of banking crises (e.g., see, recent reviews by Allen and Gale, 2009 and Laeven, 2011).
What has received less attention is the resilience of firms—and hence economies—to systemic banking crises. While many countries experience crises, not all experience similar reductions in output and employment. Levine, Lin, and Xie (2016) show that well-developed stock markets mitigate the adverse effects of banking crises by providing an alternative source of financing when crises curtail the flow of bank credit to firms. But, other factors might also shape the ability of firms to obtain financing during systemic banking crises.
In this paper, we examine whether social trust affects (a) the ability of firms to obtain financing through informal channels when crises reduce the flow of bank loans to firms and (b) the resilience of corporate profits and employment to systemic banking crises. As defined by Fukuyama (1995, p. 27) and Putnam (2000, p. 19), social trust means the expectations within a community that people will behave in honest and cooperative ways and the extent to which human interactions are governed by the norms of reciprocity and trustworthiness. By informal finance, we mean credit provision that occurs beyond the scope of a country’s formal financial and regulatory institutions. For example, firms often receive trade credit that does not involve collateral or promissory notes subject to formal judicial enforcement mechanisms (Ayyagari, Demirgüç-Kunt, and Maksimovic, 2010). Trade credit represents a large proportion of debt financing, accounting for 25% of the average firm’s total debt liabilities in our sample of over 3500 firms across 34 countries from 1990 to 2011.
Existing research suggests how social trust could enhance corporate resilience to systemic banking crises. First, when a systemic banking crisis impedes the normal bank-lending channel, access to trade credit could partially offset the reduction in bank loans and ameliorate the impact of the crisis on corporate profits and employment. Indeed, Garcia-Appendini and Montoriol-Garriga (2013) show that the 2007-2008 banking crisis triggered a surge in between-firm liquidity provision. Second, social trust could facilitate access to trade credit during a banking crisis. Karlan (2005) shows that people who view their communities as more trustworthy are more likely to lend money and payback loans even when there are no formal enforcement mechanisms in place. While firms might prefer bank loans (Ayyagari, Demirgüç-Kunt, and Maksimovic, 2010), high social trust can increase firms’ access to trade credit when bank loans are unavailable (Allen, Qian, and Qian, 2005).
Using a difference-in-differences methodology, we first assess the relation between social trust and firms’ use of trade credit, profitability, and employment during systemic banking crises. We use a sample of about 3,600 manufacturing firms across 34 countries over the years from 1990 through 2011. Data on trade credit received, profitability, employment, and other firm-level information come from Worldscope. Our key explanatory variable is the interaction term between a measure of social trust (Trust) and a crisis dummy that equals one in the start-year of a systemic banking crisis and remains one for the three years after the crisis (Crisis). To date systemic banking crises, we rely on Laeven and Valencia (2012). To measure social trust, we follow previous studies (e.g., La Porta, Lopez-de-Silanes, Shleifer, and Vishny, 1997a; Guiso, Sapienza and Zingales, 2008) and compute the percentage of survey respondents who answer “most people can be trusted” in response to the question in World Values Survey (WVS), “Generally speaking, would you say that most people can be trusted, or that you can’t be too careful in dealing with people?”. We measure Trust three years before the start of a country’s systemic banking crisis. We interpret greater values of the trust measure as suggesting that suppliers of trade credit are more confident about the trustworthiness of the demanders of such credit. If the key interaction term—Trust*Crisis—enters positively, this suggests that, on average, social trust mitigates the fall in trade credit financing, firm profitability, and firm employment during systemic banking crises.
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