Inventory investment and the choice of financing: Does financial development play a role?

This paper uses a panel of 224,604 Chinese firms over the period 2004–2009 linked with a set of unique city-level financial development data to examine how financial development affects the way corporate inventory investment is financed. We find that financial development enhances the use of interest-bearing loans and discourages the use of trade credit in financing inventory investment. These effects are more pronounced after the 2007 property rights reform, as well as for privately-owned firms, small firms, firms with no political connections, and firms located in coastal regions. Our results are robust to using a variety of different specifications, as well as different measures of financial development and estimation methods. • We use a large panel of Chinese firms to study how inventory investment is financed. • Loans (L) and trade credit (TC) are positively associated with inventory investment. • Local financial development encourages firms to switch away from TC and towards L. • These effects are stronger for more financially constrained firms. • They are also stronger after the 2007 property rights reform.