THE ROLE OF FIRM SIZE IN CONTROLLING OUTPUT DECLINE DURING THE ASIAN FINANCIAL CRISIS

Abstract

This study sets out to develop a simplified risk premium model to explain output decline within the economies of Asia in the immediate aftermath of the Asian financial crisis. Firms are allowed to borrow from both domestic and foreign banks, with the firms¡¯ debts being loosely constrained (at high levels) prior to the crisis (lending boom) but becoming tightly constrained (at low levels) on the outbreak of the crisis (lending bust). The lending rate is a function of the debt-capital ratio; thus if firms have only limited access to the credit market, then they will accumulate less capital and become small firms. Given their lower collateral, small firms face higher risk premiums which will ultimately lead to a much greater reduction in output when a credit crunch suddenly hits. Our model predicts that small firm size will accelerate unanticipated shocks; therefore, output decline will be greater in countries with small firms than in those with large firms.Asian Financial Crisis, Firm Size, Credit Constraints, Risk Premiums