Financing Constraints and Investment: New Evidence from Hospital Industry Data
Calem, Paul S., Rizzo, John A., Journal of Money, Credit & Banking
Well-known models of investment financing under asymmetric information demonstrate that agency costs may limit a firm's access to external finance.(1) That is, adverse selection or moral hazard problems may lead to less-flexible financing arrangements or to cross-subsidization of risky firms by firms that are inherently more creditworthy. For instance, agency costs in debt markets may entail credit rationing (Stiglitz and Weiss 1981) or linking of credit terms to collateral or net worth (Bernanke and Gertler 1990). In turn, such financing constraints may cause investment to vary with the availability of internal funds.(2)
A growing empirical literature investigates this theoretical link between investment and internal finance. This literature supports the view that agency costs in capital markets are a significant factor affecting investment activity.(3) In particular, investment is closely tied to availability of internal funds for many firms.(4) The present paper contributes to this literature, focusing on investment by U.S. hospitals during 1985 through 1989. This study confirms that capital market imperfections have a significant impact on hospital investment.
One limitation of existing empirical work is its almost exclusive reliance on panel data from the manufacturing sector.(5) By drawing on data from the U.S. hospital industry, we depart from this tradition. Our study expands upon existing work in two respects. First, we demonstrate that financing constraints affect firms outside of the manufacturing sector. Second, by focusing on a single, narrowly defined industry rather than examining a cross-section of industries, we avoid the problem of attributing observed differences in liquidity/investment relationships to financing constraints or industry differences.(6)
Another advantage to focusing on the hospital industry is the availability of an unusually large and comprehensive data set. Thus, our panel consists of approximately 1,400 hospitals, and our empirical analysis controls for a variety of firm characteristics to control for the marginal profitability of investment. Moreover, the structure of the hospital industry provides a natural experiment for testing the hypothesis that certain organizational forms have greater barriers to external debt financing. In particular, we examine whether small hospitals and free-standing hospitals are more likely to encounter financing constraints than are large hospitals or affiliates of multihospital systems.
Our test for financing constraints in the hospital industry may be of particular interest to health care practitioners and policymakers. There is growing concern among industry observers that access to external debt markets is becoming increasingly scarce (Sandrick 1986; Wilkinson 1988). Moreover, over the past decade, various cost containment initiatives have been implemented by third-party insurers.(7) These developments have lowered hospital operating margins and liquidity, exacerbating concerns over access to debt markets (Traska 1988).
The typical test for financing constraints appends a liquidity variable to an investment equation that also includes Tobin's Q or sales (which control for the expected marginal profitability of investment). In recent studies, certain classes of firms are identified a priori as likely to face more severe financing constraints. The studies then test for a stronger effect of liquidity among these firms.(8) For example, Hoshi, Kashyap, and Scharfstein (1991) divide their sample on the basis of membership in a keiretsu, or Japanese industrial group. Consistent with their a priori reasoning, they find a strong relationship between cash flow and investment among unaffiliated firms, but not among keiretsu members.(9,10)
A similar approach is followed in the present study. We divide our sample of hospitals according to size and chain-membership status, positing that chain-affiliated hospitals and large hospitals are less likely to face financing constraints than, respectively, free-standing hospitals and small hospitals. …