Product market decisions and product quality in the wine industry when financial constraints hit

Barriers in access to finance (i.e., financial constraints) have been shown to affect real decisions of companies such as innovation, investment in fixed capital, and employment. This paper studies whether financial frictions affect one of the most central corporate decisions – which products to produce (i.e., product mix). The hypothesis is that firms adjust their product mix in order to generate cash flows faster. As different products have different production cycles and generate cash-flow at different points in time, companies may adjust their product mix in order to shorten the cash-flow maturity.

The paper uses the Portuguese wine industry as test laboratory because this industry allows for accurate observation of product mix decisions, including the length of the production cycles. The paper analyzes firms’ reaction to a negative shock to bank credit availability. In October 2011, the European Banking Authority announced a Capital Exercise which required a subset of European banks to increase capital ratios. Companies with high exposure to affected banks faced a significant credit supply contraction following the regulation.

The paper finds that affected companies significantly rebalanced their product mix. Specifically, companies reduced the percentage of top certification wine on total production. The paper then investigates whether the reduction in the share of top certification wine was driven by the need of shortening the overall cash-flow maturity. To do this additional exercise, it exploits existing regional regulations that set minimum periods on the ageing process of certain wines. Under these regulations, companies need to decrease the relative share of constrained products in order to produce faster. The paper finds that the documented reduction in the share of top certification wine is mainly driven by companies operating in regions where a minimum ageing constraint is in place, which suggests that companies adjust product mix as a means of achieving shorter cash-flow maturities.

These findings suggest that financial constraints play a role in product mix decisions and product quality. Financial frictions may also lead to inefficiency in production if investment opportunities do not go to the most efficient producers but rather to the producers who have the funds to pursue them. Finally, the results suggest that the adverse impact of financial constraints on product markets may increase with longer, less flexible, production cycles.

Click here to go to the paper by Diogo Mendes.