Working Paper: NBER ID: w8659
Authors: Assaf Razin; Efraim Sadka; Chiwa Yuen
Abstract: This paper considers the financing of investment in the presence of asymmetric information between the 'insiders' and the 'outsiders' of the firms in a small open economy. It establishes a well-defined capital structure for the economy as a whole with the following features: low-productivity firms rely on the equity market to finance investment at a relatively low level; medium-productivity firms do not invest at all; and high-productivity firms rely on the debt market to finance investment at a relatively high level. It is shown that the debt market is efficient, with respect to both its scope and the amount of investment that each firm makes. However, the equity market fails: its scope is too narrow and the investment each firm makes is too little. A corrective policy requires just one instrument which is rather unconventional: lump-sum subsidies to those firms that choose to equity-finance their investment (i.e., equity-market-contingent grants).
Keywords: No keywords provided
JEL Codes: F21; F35; H25; H30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low productivity (O49) | equity financing (G32) |
| equity financing (G32) | narrow scope of investment (G11) |
| high productivity (O49) | debt financing (G32) |
| debt financing (G32) | higher investment levels (E22) |
| medium productivity (O49) | no investment (G31) |