This paper studies the relationship between investment and internal funds in the manufacturing sector of Shanghai with a focus on the relationship between firm size and liquidity constraints faced by manufacturing firms. By using a firm level data set in the Chinese economy in transition, we obtain a different result which contradicts the conventional wisdom that smaller firms should face a tighter liquidity constraint: Larger firms actually are more cash-constrained than smaller firms. This result is actually caused by some institutional features which are common among transition economies: (1) Facing less available means of external finance from the state banking system, small firms which are better managed and more efficient may be able to generate large enough cash flow to finance their fixed investment. (2) The presence of heavy indebtedness of large state-owned enterprises may deprive them of sufficient cash available for investment decision. Given that the state-owned enterprise have been making heavy losses, the central and regional governments have liquidity problem in satisfying their huge liquidity demands. (3) Small enterprises in non-state sector can rely on borrowing from the informal credit market although they can obtain very limited bank credit from the formal banking institutions.
Chow, K. W. C., & Fung, K. Y. M. (1998). Small businesses and liquidity constraints in financing business investment: Evidence from Shanghai's manufacturing sector (HKIBS Working Paper Series 029-978). Retrieved from Lingnan University website: http://commons.ln.edu.hk/hkibswp/24