Financing frictions: Collateral and its Effect on Firm Investment in Europe

Abstract: This thesis examines financing frictions in the European market by investigating how exogenous variation in firms' collateral through real estate value variation affects firm investment. Using a nine years dataset on European firms, we conclude that the collateral channel effect is as prominent in Europe as the one found in USA by other authors. A real estate value appreciation of one dollar indicates an increase in firm investments by five cents. The collateral effect on investments for large firms have been fairly well documented but the scarcity of private firm data has until now left this large part of the company population unexamined. Using data on private Swedish SME's between 1997 and 2008, we find that the collateral channel is of significant importance to explain investment behavior of smaller firms, extending the applicability of findings on large firm US data across firm location and size.