The role of financial development and bank credit for volatility and output growth at the firm level: Evidence from EU countries

Chapter 1 studies the response of small versus large firms to changes in banking capital position. I analyze how this response varies with firms' dependence on external finance as well as their age casing an annual firm---level dataset containing information on more than half a million public and private firms in manufacturing and construction sector for selected EU countries. The results reveal statistically significant effects of changes in banking capital on real sales growth of small and medium firms while large firms are not affected. They also indicate that a change in banking sector capital position has a stronger impact on small firms in industries with higher dependence on external finance. Another major finding is that although small and medium firms depend much more on external finance in their earlier ages, changes in bank capital position affect them more in their late ages. Intuitively, this may indicate that banks are reluctant to provide credit to a large number of young firms in European Union.;Theoretical and empirical literature so far have failed to establish a robust link between the financial development and output volatility at the firm level. In Chapter 2 I test the theoretical predictions of a general equilibrium model of financial development, risk---taking, risk---diversification and firm level volatility. I find a significant positive effect of financial development on firm---level volatility confirming the relationship predicted by the model. This finding stands in sharp contrast to a number of recent studies reporting a negative relationship between the financial development and the volatility at the firm level. Furthermore, the effect is stronger for firms in industries that are relatively more dependent on external finance. These results imply that firms requiring more external funds due to technological characteristics of the industry would choose higher risk---taking strategies in countries that are more financially developed. The results are very robust to the choice of different estimation methods which control for potential outliers and alternative measures of financial development.