Question that came up at Informs

[harishk05]

Since the "received contract financing" variable is at the project level, then how can we use this to proxy for financially constrained firms? If a firm "receives contract financing" then is it not the case that the firm is no longer financially constrained? How do we respond to this question? If you have suggestions on how to respond, please comment so we can incorporate this into the text.

[vibhuti6]

Some thoughts:

• We compare projects that received financing with those that did not. The fact that the firm receives financing indicates that it could not have carried out the project with its own funds.
• The financing only helps with project-related expenses. It is not sufficient to pull the firm out of debt or help with other financial constraints. See, for example, the following quote from FAR 32.105 :

  Contract financing methods covered in this part are intended to be self-liquidating through contract performance. Consequently, agencies shall only use the methods for financing of contractor working capital, not for the expansion of contractor-owned facilities or the acquisition of fixed assets.

• Here's another example of eligibility for certain types of contract financing:

  The contractor will not be able to bill for the first delivery of products for a substantial time after work must begin (normally 4 months or more for small business concerns, and 6 months or more for others), and will make expenditures for contract performance during the predelivery period that have a significant impact on the contractor’s working capital

• Jie had posted more details on this clause here. Also see this.
• The government also monitors the contractor's need for financing, and may choose to reduce/terminate the amount that is paid. E.g., excerpt below:

  To encourage contractors to invest their own funds in performance despite the susceptibility of the contract to termination for the convenience of the Government...

To summarize, the financing only applies for firms that would not be able to carry out the project otherwise, and only covers some project-related expenses. It is also monitored over time. So the same firm may receive financing for one project and not for another. In this sense, it is a timely indicator of the firm's financial condition when the project was ongoing.

[harishk05]

Thanks Vibhuti. This helps. It does indicate, however, that receiving contract financing at least partially mitigates the financial constraint that the firm faces -- but it may not mitigate the constraint entirely. In a way, this does help with a part of argument 2 (see page 5 here). If a firm of "very" financially constrained, payment delays and project delays are again strategic complements. So maybe receiving contract financing simply pushes a very constrained firm to be slightly constrained. This is a subtle argument though.

[JNing0]

I guess it depends on what we mean by "very" financially constrained. According to the government policy,

• To receive contract financing, the firm has to be unable to carry out the project without financing. The firm has limited cash, cannot obtain financing from the capital market/bank for this project, etc.
• The goal of contract financing is to help the firm finish the particular government project under consideration.

So I think even after receiving contract financing, the firm's financial condition on the project is likely to be more stringent that firms who do not receive contract financing for their projects. The fact that a project receives contract financing indicates that it is more financially constrained than projects without contract financing.