Do Better Institutions Mitigate Agency Problems? Evidence from Corporate Finance Choices

This paper examines how firm characteristics, the legal system and financial development affect corporate finance decisions using a novel and unexplored data set containing balance sheet information for listed and unlisted companies. Contrary to the previous literature, by using data on unlisted companies of small dimension, the paper shows that institutions play an important role in determining the extent of agency problems in corporate finance decisions. In particular, it emerges that in countries with good accounting standards and above-average creditor protection, it is easier for firms investing in intangible assets to obtain loans. Therefore, institutions that are capable of effectively protecting lenders are good substitutes for collateral. The protection of creditor rights is also important for guaranteeing access to long-term debt for firms operating in sectors with highly volatile returns. In contrast, if the law does not guarantee creditor rights sufficiently, lenders prefer to issue short-term debt because they can use the threat not to renew the loan to limit entrepreneurs' opportunistic behavior. In this case, inefficiencies due to the excessive liquidation of projects in temporary difficulty may arise. Ceteris paribus, firms are more leveraged in countries where the stock market is less developed. Moreover, unlisted firms appear systematically more indebted even after controlling for firm characteristics, such as profitability, size and the ability to provide collateral. Finally, institutions, which favor creditor rights and ensure stricter enforcement, are associated with higher leverage, but also with greater availability of long-term debt.leverage, debt maturity, agency problems, enforcement, creditor rights

Risk sharing and firm size: theory and international evidence

This paper investigates the relationship between financial development and firm size. The model shows that the efficiency of the financial system, measured by the level of monitoring costs, affects the extent of risk sharing within an economy and through this channel the availability of external finance to growing firms. If the provision of finance to projects is concentrated in few individuals and firm shocks are idiosyncratic, the risk premium is likely to rise with the amount of funds firms demand. As a consequence, keeping constant the level of opacity and risk, firms with better growth opportunities face higher costs of external finance in countries where the financial system does not favor risk sharing; this limits firm size. Empirical evidence is also provided. Financial constraints appear more stringent for firms whose optimal size is larger in countries where the financial system is less developed.risk sharing; firm size; financial constraints; financial development

Financial integration and entrepreneurial activity: evidence from foreign bank entry in emerging markets

An extensive empirical literature has documented the positive growth effects of equity market liberalization. However, this line of research ignores the impact of financial integration on a category of firms crucial for economic development, i.e. the small entrepreneurial firms. This paper aims to fill this void. We employ a large panel containing almost 60,000 firm–year observations on listed and unlisted companies in Eastern European economies to assess the differential impact of foreign bank lending on firm growth and financing. Foreign lending stimulates growth in firm sales, assets, and leverage, but the effect is dampened for small firms. We also find that firms started during the transition period of 1989-1993 – arguably the most connected businesses – benefit least from foreign bank entry. This finding suggests that foreign banks can help mitigate connected lending problems and improve capital allocation. JEL Classification: G21, L11, L14competition, emerging markets, foreign bank lending, lending relationships

On the Real Effects of Bank Bailouts: Micro-Evidence from Japan

Exploiting the Japanese banking crisis as a laboratory, we provide firm-level evidence on the real effects of bank bailouts. Government recapitalizations result in positive abnormal returns for the clients of recapitalized banks. After recapitalizations, banks extend larger loans to their clients and some firms increase investment, but do not create more jobs than comparable firms. Most importantly, recapitalizations allow banks to extend larger loans to low and high quality firms alike, and low quality firms experience higher abnormal returns than other firms. Interestingly, recapitalizations by private investors have similar effects. Moreover, bank mergers engineered to enhance bank stability appear to hurt the borrowers of the sounder banks involved in the mergers.Recapitalization, Merger, Banking Crisis

On the Mechanics of Migration Decisions; Skill Complementarities and Endogenous Price Differentials

Why are skilled workers more mobile than average? What determines positive migration flows toward relatively poorer regions or states of a country? How can one explain the sharp decrease in the mobility rate observed within European countries notwithstanding persistent regional disparities? This paper aims to answer these questions using skill complementarities and endogenous price differentials between the richest and the poorest regions. If the skill premium is increasing in the average level of human capital of a location, and the price of non-traded goods is higher in the more human capital intensive regions, the more skilled the workers are, the stronger are the economic incentives to migrate towards the richest regions. In contrast, the least skilled workers have an incentive to migrate to the poorest regions to minimize their living costs. In this context, interregional cost-of-living differentials arise endogenously if the selfselection of migrants affects total factor productivity in the traded goods sector, as pointed out by Balassa (1964) and Samuelson (1964). Moreover, if the process of capital accumulation provokes faster convergence in interregional wage differentials than in living costs, convergence in per capita GDP may hinder migration to the richest regions, even if it leaves large regional disparities.

Investor Protection, Equity Returns, and Financial Globalization

We study the effects of investor protection on stock returns and portfolio allocation decisions. In our theoretical model, if investor protection is weak, wealthy investors have an incentive to become controlling shareholders. In equilibrium, the stock price reflects the demand from both controlling shareholders and portfolio investors. Due to the high demand from controlling shareholders, the price of weak corporate governance stocks is not low enough to fully discount the extraction of private benefits. Thus, stocks have lower expected returns when investor protection is weak. This has implications for domestic and foreign investors’ stockholdings. In particular, we show that portfolio investors’ participation in the domestic stock market and home equity bias are positively related to investor protection and provide original evidence in their support

Financial Market Integration, Corporate Financing and Economic Growth

This study provides a thorough assessment of the likely effects of financial market integration on the ability of European countries to grow faster and on how the possible benefits will be distributed among the Community countries and industries. It achieves several conclusions strongly supportive of the idea that promoting financial market integration is an important step in promoting economic growth in Europe.financial development, financial integration, national financial markets, economic growth, corporate financing, Giannetti, Guiso, Jappelli, Padula, Pagano

When corporate scandal hits retail investors close to home

People reduce their participation in the stock market after a case of corporate fraud in their state, write Mariassunta Giannetti and Tracy Yue Wan

Fighting for Talent: Risk-shifting, Corporate Volatility, and Organizational Change

In the nineties, average firm size decreased, organisations decentralized, and workers preferences shifted from large to small firms. Our model identifies the economic forces behind this trend. Small firms with little capital at risk are subject to risk-shifting. They realize more of their workers‘ risky ideas, helping small firms to poach creative workers from better capitalized firms. This advantage increases if a) workers receive easier credit access, and b) technological progress raises the payoff from new ideas, provided that it remains very difficult to distinguish good ideas from bad ideas. As small firms take excessive risk, average enterprise profitability decreases, while bankruptcy increases. Moreover, large firms react through ineffecient organizational changes.financial development, spin-offs, sorting, organizations, markets