Firm Boundaries and Financial Contracts

Abstract: This paper documents how financial institutions alter their firm boundaries to overcome credit market frictions and relax financial constraints. Specifically, I examine the construction of new grain silos by a large agribusiness lender that provides credit to small farmers in Brazil, a market characterized by weak legal institutions. I exploit the staggered nature of the silo construction and employ a difference-in-differences research design to examine how this change in organizational design affects lending. I find that ownership of a silo allows the lender to significantly increase lending to both existing and new borrowers, with the effects being more pronounced for financially constrained borrowers and those exposed to more weather risk. Furthermore, it enables the lender to offer a new contract that provides a price hedge, an innovation that is particularly useful for periods with high commodity price volatility. Most importantly, the effects are stronger in municipalities with weak courts, by so emphasizing the contract enforcement channel. Thus, the paper uncovers an alternative enforcement mechanism, designed by the lender, to overcome weak creditor rights.