Formal versus informal finance : evidence from China

China is often mentioned as a counterexample to the findings in the finance and growth literature since, despite the weaknesses in its banking system, it is one of the fastest growing economies in the world. The fast growth of Chinese private sector firms is taken as evidence that it is alternative financing and governance mechanisms that support China's growth. This paper takes a closer look at firm financing patterns and growth using a database of 2,400 Chinese firms. The authors find that a relatively small percentage of firms in the sample utilize formal bank finance with a much greater reliance on informal sources. However, the results suggest that despite its weaknesses, financing from the formal financial system is associated with faster firm growth, whereas fund raising from alternative channels is not. Using a selection model, the authors find no evidence that these results arise because of the selection of firms that have access to the formal financial system. Although firms report bank corruption, there is no evidence that it significantly affects the allocation of credit or the performance of firms that receive the credit. The findings suggest that the role of reputation and relationship based financing and governance mechanisms in financing the fastest growing firms in China is likely to be overestimated.Access to Finance,Banks&Banking Reform,,Debt Markets,Bankruptcy and Resolution of Financial Distress

How well do institutional theories explain firms'perceptions of property rights?

The authors examine how well several institutional and firm-level factors and their interactions explain firms'perceptions of property rights protection. Their sample includes private and public firms that vary in size from very small to large in 62 countries. Together, the institutional theories they investigate account for approximately 70 percent of the country-level variation, indicating that the literature is addressing first-order factors. Firm-level characteristics such as legal organization and ownership structure are comparable to institutional factors in explaining variation in property rights protection. A country's legal origin and formalism index predict property rights variation better than its openness to international trade, its religion, its ethnic diversity, natural endowments or its political system. However, these results are driven by the inclusion of former socialist economies in the sample. When the authors exclude the former socialist economies, legal origin explains considerably less than openness to trade and endowments. Examining a broader set of variables for robustness, they again find that when they exclude former socialist countries, legal origin explains comparatively little of the variation in perceptions of judicial efficiency, corruption, taxes and regulation, street crime, and financing.Legal Products,Privatization,Judicial System Reform,Legal Institutions of the Market Economy,Gender and Law

Are innovating firms victims or perpetrators ? tax evasion, bribe payments, and the role of external finance in developing countries

This paper investigates corruption and tax evasion and their firm-level determinants across 25,000 firms in 57 countries, a large fraction of which are small and medium enterprises in developing countries. Firms that pay more bribes also evade more taxes. Corruption acts as a tax oninnovation, particularly that of small and young firms. Innovating firms pay a larger percentage of their revenues in bribes to government officials than non-innovating firms. They do not, however, pay more protection money to private parties than other firms. Comparing the magnitudes of bribes and taxes evaded, innovating firms and firms that use formal finance are more likely to be net victims. The findings point to the challenges facing innovators in developing countries and the role of banks in curbing corruption and tax evasion.Access to Finance,Taxation&Subsidies,Public Sector Corruption&Anticorruption Measures,Debt Markets,Public Sector Economics

Firm innovation in emerging markets : the roles of governance and finance

The authors investigate the determinants of firm innovation in over 19,000 firms across 47 developing economies. They define the innovation process broadly, to include not only core innovation such as the introduction of new products and new technologies, but also other types of activities that promote knowledge transfers and adapt production processes. The authors find that more innovative firms are large exporting firms characterized by private ownership, highly educated managers with mid-level managerial experience, and access to external finance. In contrast, firms that do not innovate much are typically state-owned firms without foreign competitors. The identity of the controlling shareholder seems to be particularly important for core innovation, with those private firms whose controlling shareholder is a financial institution being the least innovative. While the use of external finance is associated with greater innovation by all private firms, it does not make state-owned firms more innovative. Financing from foreign banks is associated with higher levels of innovation compared with financing from domestic banks.Education for Development (superceded),Microfinance,Small Scale Enterprise,Investment and Investment Climate,Innovation

Do Phoenix miracles exist ? firm-level evidence from financial crises

This paper provides empirical evidence on firm recoveries from financial system collapses in developing countries (systemic sudden stops episodes), and compares them with the experience in the United States in the 2008 financial crisis. Prior research found that economies recover from systemic sudden stop episodes before the financial sector. These recoveries are called Phoenix miracles, and the research questioned the role of the financial system in recovery. Although an average of the macro data across a sample of systemic sudden stop episodes over the 1990s appears consistent with the notion of Phoenix recoveries, closer inspection reveals heterogeneity of responses across the countries, with only a few countries fitting the pattern. Micro data show that across countries, only a small fraction (less than 31 percent) of firms follow a pattern of recovery in sales without a recovery in external credit, and even these firms have access to external sources of cash. The experience of firms in the United States during the 2008 financial crisis also suggests no evidence of credit-less recoveries. An examination of the dynamics of firms'financing, investment and payout policies during recovery periods shows that far from being constrained, the firms in the sample are able to access long-term financing, issue equity, and significantly expand their cash holdings.Debt Markets,Access to Finance,Bankruptcy and Resolution of Financial Distress,Emerging Markets,Economic Theory&Research

Small and medium enterprises across the globe : a new database

This paper describes a new cross-country database on the importance of small and medium enterprises (SMEs). This database is unique in that it presents consistent and comparable information on the contribution of the SME sector to total employment and GDP across different countries. The dataset improves on existing publicly available datasets on several grounds. First, it extends coverage to a broader set of developing and industrial economies. Second, it provides information on the contribution of the SME sector using a uniform definition of SMEs across different countries, allowing for consistent cross-country comparisons. Third, while we follow the traditional definition of the SME sector as being part of the formal sector, the new database also includes the size of the SME sector relative to the informal sector. This paper describes the sources and the construction of the different indicators, presents descriptive statistics, and explores correlations with other socioeconomic variables.Small Scale Enterprise,Small and Medium Size Enterprises,Environmental Economics&Policies,Microfinance,Economic Theory&Research,Small Scale Enterprise,Microfinance,Environmental Economics&Policies,Small and Medium Size Enterprises,Private Participation in Infrastructure

What determines protection of property rights ? An analysis of direct and indirect effects

Using cross-country data, the authors evaluate historical determinants of protection of property rights. They examine four historical theories that focus on conceptually distinct causal variables believed to shape institutions: legal origin, endowments, ethnic diversity, and religion. There is only one realization of the data with relatively few observations, which have by now been well explored in the literature. Given the correlations between the explanatory variables, it is difficult to fashion empirical tests which are consistent in their treatment of the competing theories and to know which regressions to take seriously, giving rise to competing interpretations in the literature. The authors use Directed Acyclic Graph (DAG) methodology to identify which historical factors are direct determinants of property rights protection and which are not, and subject the outcomes to a battery of robustness tests. The empirical results support ethnic fractionalization as a robust determinant of property rights protection. Despite the attention it has received in the literature, the impact of legal origin on protection of property rights appears fragile and dependent on the inclusion of transition economies in the sample.Legal Institutions of the Market Economy,Judicial System Reform,Anthropology,Gender and Law,Legal Products

How important are financing constraints ? The role of finance in the business environment

What role does the business environment play in promoting and restraining firm growth? Recent literature points to a number of factors as obstacles to growth. Inefficient functioning of financial markets, inadequate security and enforcement of property rights, poor provision of infrastructure, inefficient regulation and taxation, and broader governance features such as corruption and macroeconomic stability are all discussed without any comparative evidence on their ordering. In this paper, we use firm level survey data to present evidence on the relative importance of different features of the business environment. We find that although firms report many obstacles to growth, not all the obstacles are equally constraining. Some affect firm growth only indirectly through their influence on other obstacles, or not at all. Using Directed Acyclic Graph (DAG) methodology as well as regressions, we find that only obstacles related to Finance, Crime and Policy Instability directly affect the growth rate of firms. Robustness tests further show that the Finance result is the most robust of the three. These results have important policy implications for the priority of reform efforts. Our results show that maintaining policy stability, keeping crime undercontrol, and undertaking financial sector reforms to relax financing constraints are likely to be the most effective routes to promote firm growth.Emerging Markets,Access to Finance,Microfinance,Debt Markets,Achieving Shared Growth

INTERNATIONAL CORPORATE GOVERNANCE: A STUDY OF COMPLEMENTARITIES AND CONVERGENCE

This thesis contributes to contemporary research in international corporate governance by investigating two related questions: (1) Is there a convergence in corporate governance towards the US model as suggested by theories of functional convergence and (2) How do differing regulatory environments influence the choice of corporate governance instruments? In Part I, I examine if firms from poor investor protection regimes bond themselves to better corporate governance by listing on exchanges in more protective regimes, such as the US, thereby achieving functional convergence. I study the effect of cross-listing on ownership and control structures in a sample of 425 firms from 42 countries that cross-list on a major exchange in the US. I find the following features post cross-listing: (1) Very few firms (11 out of 262) migrate to a dispersed ownership structure, contrary to the theory that firms change their corporate governance structure by bonding to US laws (2) A significant fraction of firms experience control changes where the original controlling shareholder sells his control block to a new owner (3) 45% of the control changes result in a foreign owner and individual firm characteristics like small size and low leverage are strong predictors of a foreign control change (4) Firms that undergo a control change significantly increase their debt capacity. The findings of this section show that foreign firms use cross-listing as a means to sell control blocks and increase debt capacity rather than as legal bonding mechanisms. In Part II, I provide a theoretical motivation for the empirical finding in Part I, by deriving the features of an optimal governance system as a function of the level of investor protection in the economy. The model predicts that in an environment of poor investor protection, ownership, leverage and monitoring are complementary instruments of corporate governance where the use of one instrument increases the marginal benefit of the other. The model suggests that one cannot expect to see convergence in governance systems by changing only one aspect of the complementary cluster. Empirical evidence of the complementarities suggested by the model is provided using a sample of transition economy firms from the Amadeus Database. The two parts of the thesis together show that selection of corporate governance mechanisms involves complementarities between the mechanisms and the regulatory environment and we are not likely to see a convergence in governance structures unless there is a significant convergence in legal rules shaping the governance structures