Chapter 2

The Use of Long-Term Finance by Firms and Households: Determinants and Impact

KEY MESSAGES

• From the perspective of the firm, long-term finance offers protection from credit supply shocks and from having to refinance in bad times, facilitating long-term investments and improving performance. Because it also shields firm managers from the frequent monitoring that short-term debt requires as it comes up for renewal, long-term finance can potentially hamper investment and performance.
• Empirical evidence suggests that use of long-term finance tends to be associated with better firm performance: with developed financial institutions and markets and the ability to enter into long-term contracts, firms can grow at faster rates than they could attain by relying on internal sources of funds and short-term credit alone. Consistent with these results, recent research also suggests that differences in corporate debt maturity had important real effects during the financial crisis of 2008–09. Although government subsidies and directed credit can lengthen the maturity structure, there is no evidence that such steps are associated with better firm performance.
• Even after controlling for firm characteristics—size, asset, industry composition, and profitability— long-term finance is more prevalent among firms in high-income countries than in developing countries. Use of long-term finance by firms increases with a stable political and macroeconomic environment, better-developed financial systems, better information sharing, and sound legal institutions, including speedy contract enforcement, strong creditor rights, clear bankruptcy laws, and an effective corporate governance framework.
• Long-term finance allows households to meet different objectives throughout their life cycle. Younger households can accumulate wealth and reap term premiums through products such as bonds. Mortgages and student loans facilitate lumpy purchases of physical or human capital. Instruments such as annuities, insurance, and pensions can enable older households to insure against various life-cycle risks. Borrowing and investing in these markets also entail risks, however, and active government interventions to promote greater household participation may backfire, as in the case of U.S. subprime mortgages.
• All around the world, wealthier and more educated individuals are more likely to use longterm financial instruments as savers or borrowers. But even after accounting for individual characteristics, households’ participation in long-term finance is higher in more-developed countries with a stable macroeconomic environment, low inflation, and sound legal systems. Mortgage markets develop only at relatively high levels of GDP per capita and often depend on the availability of long-term funding through the insurance sector or stock markets.
• Government policies to promote long-term finance for firms or households should focus on addressing markets failures; removing policy distortions and maintaining a stable macroeconomic environment; promoting competitive and stable financial institutions and markets through laws; and creating policies that regulate healthy entry, operations, and exit and that provide a strong institutional environment for contract enforcement.
• For firms, an effective corporate governance framework that improves shareholder rights can lessen reliance on short-term debt. Information sharing through credit bureaus can foster long-term finance by reducing information asymmetries between firms and lenders. Collateral registries for movable assets can help firms increase the amount of assets that they can post as collateral to obtain long-term loans. Appropriate contract law or leasing legislation can encourage leasing institutions to provide finance for fixed assets.
• For households, financial literacy, consumer regulation, disclosure rules, and the provision of investment default options can have important effects on increasing understanding of longterm finance instruments and on reducing financial mistakes stemming from lack of proper information and behavioral biases.

RELATED LINKS

• Anginer, Deniz, Aslı Demirgüç-Kunt, Vojislav Maksimovic, and Mete Tepe. 2015. “Is Short-Term Debt a Substitute or a Complement to Good Governance?” World Bank, Washington, DC.
• Badev, Anton, Thorsten Beck, Ligia Vado, and Simon Walley. 2014. “Housing Finance across Countries: New Data and Analysis.” Policy Research Working Paper 6756, World Bank, Washington, DC.
• Berg, Gunhild, and Bilal Zia. 2013. “Harnessing Emotional Connections to Improve Financial Decisions: Evaluating the Impact of Financial Education in Mainstream Media.” Policy Research Working Paper 6407, World Bank, Washington, DC.
• Bruhn, Miriam, Luciana de Souza Leão, Arianna Legovini, Rogelio Marchetti, and Bilal Zia. 2013. “The Impact of High School Financial Education: Experimental Evidence from Brazil.” Policy Research Working Paper 6723, World Bank, Washington, DC.
• Bruhn, Miriam, Gabriel Lara-Ibarra, and David McKenzie. 2013. “Why Is Voluntary Financial Education So Unpopular? Experimental Evidence from Mexico.” Policy Research Working Paper 6439, World Bank, Washington, DC.
• Cull, Robert, Gan Li, Nan Gao, and L. Colin Xu. 2014. “Effect of Access to Informal Finance on Consumption: Evidence from a Representative Sample of Chinese Households.” Unpublished paper, World Bank, Washington, DC.
• Demirgüç-Kunt, Aslı, María Soledad Martínez Pería, and Thierry Tressel. 2015a. “Determinants of Corporate Capital Structures.” World Bank, Washington, DC.
• ———. 2015b. “The Impact of the Global Financial Crisis on Firms’ Capital Structures: The Role of Financial Markets and Institutions.” World Bank, Washington, DC.
• Knack, Stephen, and L. Colin Xu. 2015. “Unbundling Institutions for External Finance of Firms. Worldwide Firm-level Evidence.” Policy Research Paper 7287, World Bank, Washington, DC.
• Liu, Chong, and L. Colin Xu. 2014. “The Causes and Consequences of Long-Term Finance in China.” Unpublished paper, World Bank, Washington, DC.
• Long, Cheryl, L. Colin Xu, and Jin Yang. 2014. “Formal and Informal Financing of Chinese Private Firms over the Decades: The Role of Political Connections, Property Rights, and Firm Size.” Unpublished paper, World Bank, Washington, DC.
• Love, Inessa, María Soledad Martínez Pería, and Sandeep Singh. Forthcoming. “Collateral Registries for Movable Assets: Does Their Introduction Spur Firms’ Access to Bank Finance?” Journal of Financial Services Research.
• Martínez Pería, María S., and Sandeep Singh. 2014. “The Impact of Credit Information Sharing Reforms on Firm Financing.” Policy Research Working Paper 7013, World Bank, Washington, DC.
• Park, Haelim, Claudia Ruiz-Ortega, and Thierry Tressel. 2015. “Determinants of Long- vs Short-Term Bank Credit in EU Countries.” World Bank, Washington, DC.