Organizational Form and Financing Constraints : Evidence from the Indonesian Manufacturing Industry

This paper investigates how, in a developing country, where credit market and legal institutions are weak, firms' choice of organization form, i.e., noncorporate versus corporate, affects their access to capital markets. I use data from Indonesian manufacturers from 1992 to 1998 to show that incorporated firms are less reliant on internal financing than unincorporated firms. Moreover, a 1995 reform that increased the possibility of seizing firms' assets under bankruptcy and the reporting requirements for corporations decreased their reliance on internal financing relative to unincorporated firms. These results suggest that incorporation, which enables asset seizure in the case of bankruptcy and by requiring reporting of financial statements and enabling asset seizure in the case of bankruptcy, serves as a costly signal of quality and increases access to external financing. JEL codes: G32, O16, P48, I18 ♣ I would like to thank Arik Levinson and Billy Jack, for their comments and supervision; Steve Olley; participants of an empirical microeconomic brown bag seminar sponsored by Georgetown University’s Department of Economics, and Mohamad Ikhsan at the Institute for Economics and Social Studies of the University of Indonesia for granting access to the Indonesian manufacturing industry database. I can be contacted via e-mail at: [email protected].