FIN-02-023 |
NYU Stern School of Business |
September 2002
Heitor Almeida and Daniel Wolfenzon
ABSTRACT
Abstract
We model the equilibrium allocation of capital in the presence of imperfect institutional
development. In our model, imperfect institutional development reduces external market
activity by limiting capital flows among firms, thus compromising the efficiency of economy
wide capital allocation. We show that the efficiency of capital allocation increases with
firms’ external financing requirements because higher external financing requirements lead
to more liquidation of projects and a more active external capital market. Furthermore,
a higher degree of conglomeration reduces external market activity because conglomerates
allocate capital internally rather than supply it to the market. Thus, the efficiency of capital
allocation may decrease in the presence of conglomerates, even when they allocate capital
internally to their most productive units. Our results help explain why countries that rely
heavily on external finance also have high productivity and growth, and they provide a new
perspective on the recent debate about the desirability of dismantling business groups in
developing countries. The fact that the main results of the paper run against the intuition
obtained from partial equilibrium models shows the importance of modeling financial imperfections
in an equilibrium framework in order to derive implications about overall economic
efficiency.
Heitor Almeida
Institution: Leonard N. Stern School of Business at New York University
Phone: 212-998-0279
Fax: 212-995-4233
Email: halmeida@stern.nyu.edu
Homepage:http://pages.stern.nyu.edu/~halmeida
Daniel Wolfenzon
Institution: Leonard N. Stern School of Business at New York University
New York, NY 10012
Phone: 212-998-0309
Fax: 212-995-4233
Email: dwolfenz@stern.nyu.edu
Homepage:http://pages.stern.nyu.edu/~dwolfenz
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