Financial Constraints and Firms' Pricing Decisions

This paper empirically examines the impact of financial constraints on Japanese firms' pricing behavior. In spite of a large swing in demand in the bubble era and the lost decade, aggregate prices did not fluctuate much in these periods. Such price rigidity can be explained by customer market theory, which suggests that firms invest in the customer stock, i.e., market share, by charging low prices in booms, while they do not cut their prices for locked-in customers in recessions. This theory implies that the pricing decision is an investment problem, and opens the possibility for financial factors to affect the pricing decision. The estimation results show that financial positions affect the pricing behavior of large firms, but not that of small firms. The impact of financial positions on large firms' prices is counter-cyclical, and this characteristic is clearly observed in the industries that produce differentiated goods such as advanced machines. In contrast, small firms whose product brand is not well established in the market cannot lock in customers, and hence financial constraints do not affect their pricing decisions.