Financial constraints and capacity adjustment in the United Kingdom: Evidence from a large panel of survey data

The interrelationship between financial constraints and firm activity is a hotly debated issue. The way firms cope with financial constraints is fundamental to the analysis of monetary transmission, of financial stability and of growth and development. The CBI Industrial Trends Survey contains detailed information on the financial constraints faced by a large sample of UK manufacturers. This paper uses the quarterly CBI Industrial Trends Survey firm level data between January 1989 and October 1999. The cleaned sample contains 49,244 quarterly observations on 5,196 firms. As more than 63% of the observations refer to firms with less than 200 employees, the data set is especially well suited for comparing large and small companies. The data set is presented and a new method of checking the informational content of the data is developed. Whereas the relationship between investment activity and financial constraints is theoretically ambivalent due to simultaneity, the link between financial constraints on the one hand and the prevalence and duration of capacity gaps on the other should be unambiguously positive. Looking at the relationship between both types of constraints, two important results emerge. First, there is shown to be informational content in the survey data on financial constraints. Specifically, financially constrained firms take longer to close capacity gaps. This indicates that financial constraints do indeed play a part in the investment process. Second, small firms close their capacity gaps faster than large firms do, but financial constraints seem to be of higher relevance to their adjustment dynamics.