This paper investigates the role of financial factors (cash flows and leverage) in the investment of Indonesian firms, therefore, indirectly examines the existence of the balance channel of the monetary transmission mechanism. By using Euler's equation in addition to the q equation, we are able to check the consistency of the results. Financing of non-financial firms varies from country to country, according to the institutional structure of the countries' financial systems.
The financial structure of the corporate sector in developing countries has been the subject of recent studies (Singh and Hamid, 1992, and Glen and Pinto, 1994). The latter is calculated as an average of the debt-to-equity ratio of the sample firms reported on the individual firm's balance sheet. It can also be observed that the debt-equity ratio of affiliated firms is greater than that of independent firms.
Methodology
As discussed in the previous section, with imperfect information where the external funds are more expensive than internal funds, companies with lower cash flows are likely to be more constrained in their investment decision. We can further predict that under asymmetric information, the sensitivity of investments to cash flows should be different between firms. There are some problems with testing financial constraints in the context of Tobin's q-models.
If the assumption of perfect competition in the company's product market does not hold, the average q is no longer a valid proxy for marginal q. Instead, the approach is based on the idea that investment rates for the next period are positively related to the investment rate in the current period. In the standard Euler equation, the expectation of the next investment rate therefore summarizes the same information as in the q ration.
In the standard Euler equation, under the null hypothesis of no financial constraint, β1 is positive and greater than one, β2 is negative and greater than one, β3 is positive, β4 is negative, β5 is zero under Modigliani-Miller debt irrelevant and negative otherwise (Bond and Meghir, 1994). Under alternative hypothesis, the equation (2) will be misspecified, that is, the investment will be positively related to the gross profit, β4 is positive. Therefore, we can expect firms affiliated to these groups to be less sensitive to cash flows due to both the mitigation of the information problem and the internal capital market (Schian-tarelly, 1996).
Share ownership of 'small' listed firms tends to be less concentrated, so the agency problem between managers and outside investors is less severe (see for example, Devereux and Schiantarellly, 1990). Of the 304 firms listed on the Jakarta Stock Exchange, more than 40% are owned by business groups (Indonesian Business Data Centre, 1996).
Data and Econometrics Methods 5.1. Data
Another interesting feature of our data is that less financially constrained firms are characterized by a high Tobin's q and the Tobin's q of the affiliated firms is the highest among the groups.11 5.2. Third, the possible heteroskedasticity of the disturbance vit since the panel data cover many heterogeneous firms and several time periods. Arrelano and Bonds (1991) provide Generalized Method of Moments (GMM) estimators for dynamic panel data that have the above properties.
Given that vit is serially uncorrelated, in the first difference models, the error term becomes a first-order moving average, MA (1). 1 1 Pomerleano (1998) notes that the high Tobin's q of these large companies may be associated with the. However, in a recent empirical work, Hall, Mairesse and Mulkay (1998) found that the GMM method of estimation results in a lot of inaccuracy in the estimated parameters.
Using simulation studies, Alonso-Borrego and Arrelano (1996) also find that the first difference GMM estimator produces a large sample bias and poor precision, especially in fitting dynamic panel data models with a small number of time series observations and large autoregressive parameters. . The problem stems from the "weak instruments" of the variable levels in the first difference equations. Some progress has been made by Blundell and Bond (1998) to improve the GMM estimator by introducing additional restrictions on the initial conditions process, which allows the use of lagged first differences of variables in the level equations in addition to lagged level instruments in the first. differential equations as in first differenced GMM.
Since our sample is also characterized by a small number of time series observations, we follow this approach and use the DPD98 program (Arrelano and Bond, 1998) which was run in the Gauss 386i. Due to the heteroskedastic nature of the data, a two-step estimation procedure of the DPD98 program was used to obtain a more efficient estimation.
Empirical Results
If Tobin's q as well as sales can perfectly control expected profitability, then the importance of cash flows in the investment equation supports the financial constraint hypothesis. Another interesting result is that the leverage ratio (debt-to-equity ratio) has the expected (negative) sign and is highly significant when we estimate it using GMM (SYS). The most interesting result is that the coefficients of cash flows are positive and highly significant for both groups of firms, which means that the financial factor is important for both groups.
Another reason is that the strict assumption of using the mean as the proxy of marginal q, such as perfect competition in the output market, can be violated. A possible explanation for the positive and significant non-leverage coefficient for the member firms is their interlocking relationship with domestic banks and their access to foreign sources of finance, as suggested by the large inflows of capital in the sample period (see Pomerleano, 1998, Claessen, 1998). ). In fact, q is higher for the less financially limited companies than for the limited companies (see descriptive data in Appendix 2).
Wald test is a test of joint significance of the coefficients distributed asymptotically if χ2 below the zero of no significance. Thus, the positive sign of the gross profit term could reflect the existence of financial constraints in the capital market. Notes: See note to Table 1, a t-statistic for the null hypothesis that the coefficients on cash flows (and debt) of the two groups are the same.
Finally, the signs of the coefficients on debt duration are consistent with those estimated in the Tobin's q model, i.e. positive and highly significant for less limited companies and negative for companies with limited limitation.1 4 Furthermore, the t-statistics for differences in debt coefficients between the two groups of companies are significant in all cases. Wald test is a test of the joint significance of the coefficients, asymptotically distributed as X2 below zero significance.
Conclusion and Policy Implication
Evidence on the role of the cash flow investment equation suggests the existence of financial constraints for firms classified a priori as financially constrained and unconstrained. The investment spending of financially constrained firms reacts negatively to the level of financial leverage. The evidence provides some support for the financial constraints hypothesis and provides indirect evidence for a broad credit channel of monetary policy.
The response of the real sector to a monetary policy shock depends on the financial structure of firms, the segmentation of the financial market between large and small firms, and the degree of financial/credit frictions in the capital/credit market. Data such as ability of firms to access banks' credit, debt-to-equity ratio and banks' willingness to lend provide at least indicators of financial friction in the credit market.1 5. What the financial crisis in Southeast -Regarding Asia, although still a subject of debate (see IMF, 1999), some have provided evidence that the credit channel is operating in countries in the region in the wake of the crisis (Ding et al., 1998, Kim, 1999, and Ito and Da Silva, 1999).
Therefore, monetary authorities should be aware of the potential reinforcing and dispersive effect of their policy. The Asian financial crisis, characterized by disruption due to credit flows resulting from the collapse of banks/financial intermediation, resembles the Great Depression in the 1930s, and thus is perhaps an interesting setting for research on 'financial institution failure' in spread. of the financial crisis, as done by Bernanke (1983) when he pioneered the notion of the credit channel. Sources of funds include the sum of cash flows and funds raised from external sources, net of external borrowing costs and agency costs. Use of funds includes distributed earnings (dividends) and new capital expenditures.
According to (A.8), the optimal condition requires today's marginal investment costs to be equal to the marginal return on the new unit of capital after deducting the user costs plus the savings in marginal adjustment costs from the absence of the investment. In the empirical model we also introduce the output capital ratio which can be significant if the product market is imperfect.
Definition of variables used
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