banks hold around 25 percent of banking sector assets; their performance has deteriorated significantly in the recent years due to weakened governance structure. Private commercial banks, though better in terms of governance, have efficiency issues; they charge high interest rates, which affect commercial viability of the investments. Foreign banks’ activities are predominantly in offshore and foreign trade business. Capital markets are still at a nascent stage: in February 2014 the market capitalization of the Dhaka and Chittagong stock exchanges relative to GDP was around 20 percent lower than in India, Pakistan and Sri Lanka. It is clear that financial constraints are particularly salient for Bangladeshi firms.

The Bangladesh Panel Survey, part of the group of Enterprise Surveys, is conducted by the World Bank and is unique in that it is a panel data set taken semi-annually over the years 2003 to 2005.<sup>32</sup> There are 259 privately owned firms in the panel representing six different manufacturing sectors. Surprisingly few firms drop out of the survey. There are 241 firms that are present in all 6 periods. Firms were sampled from the two major cities, Dhaka and Chittagong, and are representative of the industrial composition of the Bangladesh economy. More than half the sample is in either the Garment or Textile industry, 28% and 26% respectively. The rest of the sample is distributed in Food (15%), Leather (12%), Electronics (9%) and Chemicals (10%). There is substantial variation in firm size. The interquartile range is 264 employees with the median at 150. About 37% of firms have fewer than 100 employees, and 85% have fewer than 500 employees. There is a tendency for firm surveys in developing countries to over sample larger firms, which may not be representative of the microenterprises that often characterize developing economies.

The panel contains several indicators for financial constraints. My first measure of financial constraint is the manager’s subjective assessment of whether access to financing is a problem. They report on a scale from 0 to 4 with 1 corresponding to a minor problem and 4 corresponding to a severe problem.<sup>33</sup> I define the dummy _acc_ = 1 if the firm described access to finance as moderate to severe problem.<sup>34</sup> The second measure uses the composition of the sources of finance. As shown in Figure 1, firms report the share of finance from each of 14 different sources. I define a second financial constraint dummy, _internalF_ = 1 if 100% of financing comes from internal funds and the firm reported at least some problem with access to financing.<sup>35</sup> A firm that finances operations entirely from internal funds is one that does not utilize external credit. Under the model’s framework, this implies either the firm is matured and does not need external finance (and these firms are not considered financially constrained by _internalF_ ), or the firm is financially constrained. I also include indicators typically used in the literature such as age and size of the firm (Cooley and Quadrini (2001); Cabral and Mata (2003)). The dummy _age_ 5 = 1 if the firm is 5 years old or less and _size_ 100 = 1 if the number of employees is 100 or fewer. The measures that utilize financial composition and subjective assessment indicate that a substantial proportion of the firms are financially constrained, consistent with the poor investment climate of Bangladesh; 67% are constrained according to the internal finance indicator and 44% according to the access to finance indicator. The proportion of firms constrained according to indicators _age_ 5 and _size_ 100 are considerably lower, 15% and 38%

> 32Enterprise Surveys were previously called the Investment Climate Surveys (ICS). The Bangladesh Panel Survey was carried out by the World Bank in conjunction with the South Asia Enterprise Development Facility and the Bangladesh Enterprise Institute.

> 33The access to finance question is asked only in years 2004-2005. Missing values were supplemented with predicted values from age, size and bank loan variables. The prediction matched 76% of the actual values.

> 34Moderate to severe problem corresponds to responses of 2, 3 or 4.

> 35Internal finance is available for all years but the response rate dropped to approximately 50% in 2004. Missing values were supplemented with predicted values from access. The predicted values matched 60% of the actual values.

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