Agency Costs, Financial Deregulation, and Corporate Investment - An Euler Equation Approach to Panel Data for Swedish Firms

This paper studies the influence of debt financing on the investment behavior of firms. The empirical analysis is based on the Euler equation governing the optimal level of investment in the presence of convex adjustment costs of capital as well as agency costs associated with borrowing in imperfect capital markets. Using a large panel of Swedish firms over the period 1979-94, we examine whether agency costs differ between firms of different size and between firms with different retention behavior, and whether Swedish financial deregulation in the mid 1980s helped to reduce these costs. In addition to the structural and highly nonlinear Euler equation, we estimate a linearized version of it. The empirical results support the existence of agency costs, but there is no evidence that these costs would differ between classes of firms, nor that deregulation succeeded in reducing them. It appears, however, that some firms may not only be facing agency costs, but may also be rationed altogether.