Financial Constraints, Corruption and Growth: Firm Level Evidence

This paper looks at the interactive effects of bribes and financial constraints on firm growth. Existing empirical work, such as Fisman and Svensson (2007) find the rate of taxation and bribery are negatively correlated with firm growth, has been challenged by the positive association between bribes and growth caused by the tendency for better performing firms to be targeted or are more capable to pay higher amounts of bribes. I propose that the effect of bribes on firm growth is better identified through their demands on liquidity. Utilizing a unique panel dataset that contains information on both liquidity constraints and bribe payments of the firm, I test whether bribes on the procurement of business licenses affect the growth of firms that are financially constrained. Results show that a one percent point increase in bribes is associated with a decrease of between 0.22 to 0.26 of a percentage point in growth for financially constrained firms while for non-financially constrained firms, bribes may be positively associated with growth. The interaction between financial constraints and bribes show that bribes can be distortionary even when bribes act as fixed costs. These results imply that corruption alone may not be detrimental to firm growth but when combined with limited access to finance, the cost of corruption seriously hampers the growth of firms. One policy implication is that tackling the issue of financial constraints need not only be through improving the supply of credit, but may also include decreasing the demands on liquidity such as minimizing the unnecessary costs imposed on firms in the form of bribes.