Liquidity Constraints, Kinship Networks, and the Financing of Household Investment

Abstract

We look at liquidity constraints and the financing of household investment in fixed assets. We find that rural households in our sample, especially the poor, seem to face liquidity constraints. The constraints are partially mitigated by kinship networks in the village. When we further analyze gift and borrowing transaction data, we find that the kinship effect for the poor households seem to be through both gifts and borrowings while the effect for the rich households is more likely to be from gifts and not from borrowing. Using the accounting distinction between the use of a stock of cash and the cash flow, we find that rich households finance investment from previously accumulated cash, i.e. they use internally generated funds, symptomatic of constraints in a pecking order literature. As a result, we argue that although investment-cash flow sensitivity implies liquidity constraints, the reverse is not guaranteed. Finally, we also find evidence consistent with the fact that the network effect may come in both direct channels (gifts and borrowing from people within village) and indirect channels (signal of quality by being a part of the network).

Keywords: Investment-cash flow sensitivity, financial constraint, liquidity, household investment, networks

JEL Classification: O12, O16, G3, E01, M41