Not All Industries, Firms Benefit from Stock-Market Liberalization
In developing countries, stock-market liberalization disproportionately benefits large, established firms in industries that depend on external finance and/or have better growth opportunities.
ANN ARBOR, Mich. Developing countries commonly use stock-market liberalization as a means to stimulate industrial growth. This allows foreign investors to purchase shares in the country's stock market and, in effect, eases credit constraints.
However, new research indicates that liberalization disproportionately benefits particular types of industries and firms, thereby failing to provide the broad-based economic stimulus these countries seek to achieve.
Industries that depend more heavily on external sources of finance and those that face better growth opportunities grow significantly faster following stock-market liberalization, say Kathy Yuan, assistant professor of finance at the University of Michigan's Stephen M. Ross School of Business and Nandini Gupta of Indiana University. Their findings indicate liberalization reduces the incremental, rather than the overall, cost of external capital.
In addition, within industries that benefit most from liberalization, the increase in growth occurs primarily through an expansion in the size of existing firms rather than through the creation of new firms, the researchers say. This is not surprising in emerging markets, they add, where larger, established firms are more likely to use the stock market to raise capital.
"Our results suggest liberalization facilitates economic growth not simply by reducing the overall cost of capital in the economy, but by reducing market imperfections that drive a wedge between the internal and external cost of capital," Yuan said.
Yuan and Gupta emphasize the importance of considering the effects of political and economic factors that also may influence post-liberalization growth, possibly resulting in an overestimation of the actual impact of having better growth opportunities. For example, industries with high future growth expectations may lobby for stock-market liberalization and thus be in a position to benefit disproportionately from their government's policy decision to liberalize.
Yuan and Gupta studied 31 emerging economies, of which all but four liberalized their stock markets between 1986 and 1995. Their evidence may prove useful for the design of liberalization programs and accompanying industrial policies.
"Our results raise a question about the reach of the liberalization effect, and whether liberalizing stock markets can ease access to credit for small and medium firms that typically face the greatest credit constraints," Yuan said. "From a policy perspective, it would be important to consider the implementation of accompanying economic reforms, such as industrial deregulation or bank privatization, which could have a complementary impact on new firm growth."
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