POLicY REsEAkCH WORKINC. PAPER 1724

# Summary findings

Economic policymakers traditionally hold the view that, because of imperfectioms **in** capital markets, a shortage of long-terrn finance acts .-s a barrier to industrial performance and growth. ILong-term finance is thought to allow fhrmn to invest in more productive technologies, even when they do not produce immediate payoffs, without the fear oi premature liquidation. As a result, special state-supported term-lendirng institutions have been established, especially in developing countries.

But sonic believe that short-term finance may offer better incenrivcs because it allows suppliers of finance to monitor and montrol firms mnore effectively, thus improving the firms' performance.

Schiant,; -rh, **aind** Si ivis-lava en-pirically investigate the deterrlinaiits and Lonseqoences of the term structure of debt. Using a rich p.ncl of data on privately owned cornpanits in India, tl-ev also examine the influence of debt manu-ity strictures **oIn** those firms' performance, especially on productivity The results are not conclusive, but seem to support conventional beliefs about the importance of long-term finance to firm performance. Heavy leveraging, however, has a strong negative impact on productivity.

They base their econometric evidence on estimates of a maturity equation and of a production function augmented by financial variables.

The data on which these results are based have been generated by a financial system in which there is little competition, in which state-owned financial institutions are not guided by the profit motive and have no control over interest rates, so one cannot say whether short term finance would have been more beneficial in a less regulated system.

Moreover, by the end of the 1980s, the capital base of India's government-owned financial institutions had been severely eroded and they carried a heavy burden of nonperforming assets. This means that the benefits of long term finance must be weighed against the costs.

This paper -- a prod; ct of the Finance and Private Sector Development Division, Policy Research Department - was prepared for tlc conferernce "Firm Finance: Theory and Evidence," Finance and Private Sector Development Division, Policy Research Departinent, June 14, 1996. The study was funded by the Bank's Research Support Budget under research project 'Term F.nance" (RPO 679-62). Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington DC 20433-0001. Please contact Bill Moore, room N9-038, telephone 202-473-8526, fax 202-522-1 155, internet address gmoore@worldbank.org. February 1997. (29 pages)

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