Why International Equity Inflows to Emerging Markets are Inefficient and Small Relative to International Debt Flows

Assaf Razin, Efraim Sadka and Chi-Wa Yuen

No 8659, NBER Working Papers from National Bureau of Economic Research, Inc

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).

JEL-codes: F21 F35 (search for similar items in EconPapers)
Date: 2001-12
Note: IFM ITI
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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