We exploit time variation in the degree of development of local credit markets and
matched employer-employee data to assess the role of the firm as an internal credit
market. In less developed local credit markets firms can offer a flatter wage-tenure
profile than firms in more developed credit markets to lend implicitly to their
workers or offer a steeper profile to implicitly borrow from their workers. We find
that firms located in less financially developed markets offer wages that are lower at
the beginning of tenure and grow faster than those offered by firms in more
financially developed markets, helping firms finance their operations by raising
funds from workers. Because we control for local market effects and only exploit
time variation in the degree of local financial development induced by an exogenous
liberalization, the effect we find is unlikely to reflect unobserved local factors that
systematically affect wage tenure profiles. The size of implicit loans is larger for
firms with more problematic access to bank credit and workers less likely to face
credit constraints. The amount of credit generated by implicit lending within the
firm is economically important and can be as large as 30% of bank lending.
Consistent with credit market imperfections opening up trade opportunities within
the firm, we find that the internal rate of return of implicit loans lies between the
rate at which workers savings are remunerated in the market and the rate firms pay
on their loans from banks.