CONCLUSION AND POLICY IMPLICATIONS

POLICY IMPLICATIONS

A quite striking observation to emerge from the empirical analysis is that in no country do securities markets contribute a large proportion of corporate sector financing. In some countries, the average net contribution was close to or less than zero. Equity markets are particularly deficient in this respect. That is not to say that equity markets do not perform an important function. 

They may promote allocative efficiency by providing prices that guide the allocation of resources or productive efficiency through reallocating existing resources via, for example, the takeover process. But in terms of aggregate corporate sector funding, their function appears limited. Instead, a majority of external finance comes from banks. Why? Neither transaction costs nor taxation were found to provide adequate descriptions of corporate financing patterns in different countries. 

One interpretation for the preponderance of bank finance is that financial intermediaries perform a central function in diminishing one of the most serious deficiencies of financial markets: asymmetries in information. According to this view, banks play an important role in collecting and processing information that markets are unable to do or can do only at high cost. There is almost certainly a large element of truth in this story. 


But the analysis of the section 12.3 suggested that imperfect information is not an adequate description on its own. Information gathering can be quite effectively performed by institutions other than banks. Furthermore, the distinguishing feature of banks in different countries does not appear to be the nature of or the way in which they collect information. Instead, it is the extent to which and the form in which institutions influence the activities of firms that appear to show marked variations across institutions and countries.


 Is control direct in the form of representation on the boards offirms or indirect in the form of takeovers? Do financial institutions or individual shareholders initiate changes in control? How easy is it to form coalitions of shareholders or bond holders and how serious are free-rider problems of control? The analysis in the previous section suggested that control theories provide a good basis for understanding the 10 stylized observations of this paper. They emphasize the managerial functions of financial institutions and suggest that the central role of banks comes from their ability to intervene and take control at comparatively low cost.


 If this is right, then the implication of both the empirical observation of a preponderance of external finance coming from banks and control models of corporate finance is that banks may be superior to markets in promoting economic development and growth. 


This may be particularly true in the early stages of development of both economies and firms before reputations have been established and adequate incentives exist to bring borrowers' and lenders' interests into line. In the longer term intermediaries may be less central to the development of firms.13 But in the early stages of the growth of firms and economies an efficient banking system may be an essential requirement for expansion.