internal capital markets and the competition for corporate resources this article examines the role of corporate headquarters in allocating scarce resources to competing projects in an internal capital market unlike a bank headquarters has control rights that enable it to engage in winner picking the practice of actively shifting funds from one project to another by doing a good job in the winner picking dimension headquarters can create value even when it cannot help at all to relax overall firm wide credit constraints the model implies that internal capital markets may sometimes function more efficiently when headquarters oversees a small and focused set of projects this article analyzes the process by which internal capital markets channel limited resources to different uses inside a company in so doing it seeks to address two related sets of questions first what is the fundamental economic rationale for creating an internal capital market that is under what circumstances can it make sense to combine several technologically distinct projects under one roof and have them seek funding from corporate headquarters as opposed to setting them up as stand alone companies that each raise external financing on their own second given this rationale what is the optimal size and scope of an internal capital market should headquarters be involved in funding a large number of projects or just a few and should these projects be unrelated to one another or in similar lines of business the answers to both sets of questions flow from the insight that in a credit constrained setting where not all positive npv projects can be financed headquarters can create value by actively reallocating scarce funds across projects for example the cash flow generated by one division s activities may be taken and spent on investment in another division where the returns are higher or alternatively one division s assets may be used as collateral to raise financing that is then diverted to the other division simply put individual projects must compete for the scarce funds and headquarters job is to pick the winners and losers in this competition

stochastic dominance and mean variance measures of profit and loss for business planning and investment in this paper we first extend the stochastic dominance sd theory by introducing the first three orders of both ascending sd asd and descending sd dsd to decisions in business planning and investment to risk averse and risk loving decision makers so that they can compare both return and loss we provide investors with more tools for empirical analysis with which they can identify the first order asd and dsd prospects and discern arbitrage opportunities that could increase his her utility as well as wealth and set up a zero dollar portfolio to make huge profit our tools also enable investors and business planners to identify the third order asd and dsd prospects and make better choices to complement the stochastic dominance approach we also introduce an improved mean variance criterion to decisions in business planning or investment on both return and loss for risk averse and riskloving investors we then illustrate the superiority of the present approaches with well known examples in the literature and discuss the relationship between the improved stochastic dominance and mean variance criteria

are rich people smarter abstract we formulate a general stochastic process of wealth accumulation by capital investment and analyze the conditions required to ensure convergence to the empirically observed pareto wealth distribution while homogeneous investment talent leads to the pareto distribution under very general conditions even a mild degree of differential investment talent results in a non pareto wealth distribution this finding suggests that chance rather than differential investment talent is the dominant factor in the process of wealth accumulation by financial investment our findings conform with market efficiency and may have implications regarding the origins the economic significance and the social desirability of wealth inequality at the high wealth range

aging population retirement and risk taking the increase in life expectancy spells disaster at retirement one can solve this problem by investing in the maximum geometric mean mgm portfolio which is empirically composed from equity for a t 30 year horizon or more the mgm portfolio dominates other investment strategies by almost first degree stochastic dominance the mgm portfolio also maximizes the expected value of the commonly employed preferences and prospect theory value function for various loss aversion parameters and various reference points for t 10 life cycle funds would increase virtually all investors welfare by shifting to the mgm portfolio so long as the investment horizon is at least 10 years this paper was accepted by amit seru finance

almost stochastic dominance and stocks for the long run abstract the geometric mean argument and the recently developed almost stochastic dominance criterion have been employed to make the case for stocks for the long run we show that almost stochastic dominance and the geometric mean argument do not necessarily support long run investment in equities in fact for standard preferences bonds may be preferred to stocks for the long run while stocks are preferred for shorter horizons

a comparison of time varying parameter and multiprocess mixture models in the case of money supply announcements this study compares the performance of a recently proposed multiprocess mixture model and a random walk time varying parameter tvp model using the interest rate weekly money relationship for illustrative purposes for the case of this relationship which is subject to regime shifts and outliers the mixture model performs well and the latter model performs poorly this finding is of general interest since investigators often adopt random walk tvp models to accommodate potential regime shifts in regression relationships the tvp estimation procedure is unlikely to find abrupt shifts since the estimate of parameter variance is based on the entire data sample in the face of rapid discontinuous shifts in the parameters this variance estimate is unrepresentative of the variability during periods of abrupt shift or transient observations

finance firm size and growth the authors examine whether financial development boosts the growth of small firms more than large firms and hence provides information on the mechanisms through which financial development fosters aggregate economic growth they define an industry s technological firm size as the firm size implied by industrial specific production technologies including capital intensities and scale economies using cross industry cross country data the results indicate that financial development exerts a disproportionately large effect on the growth of industries that are technologically more dependent on small firms this suggests that financial development accelerates economic growth by removing growth constraints on small firms and also implies that financial development has sectoral as well as aggregate growth ramifications

is it inefficient investment that causes the diversification discount diversified conglomerates are valued less than matched portfolios of pure play firms recent studies find that this diversification discount results from conglomerates inefficient allocation of capital expenditures across divisions much of this work uses tobin s q as a proxy for investment opportunities therefore hypothesizing that q is a good proxy this paper treats measurement error in q using a measurement error consistent estimator on the sorts regressions in the literature i find no evidence of inefficient allocation of investment the results in the literature appear to be artifacts of measurement error and of the correlation between investment opportunities and liquidity diversif ied conglomerates appear to trade at a discount relative to matched portfolios of pure play firms studies documenting this stylized fact include lang and stulz 1994 berger and ofek 1995 comment and jarrell 1995 and servaes 1996 recent empirical work has sought to find the source of this diversification discount building on the theoretical work in milgrom and roberts 1990 stein 1997 and scharfstein and stein 2000 on the inefficiency of internal capital markets this literature has asked specifically whether diversified firms allocate their capital expenditures inefficiently across divisions the canonical answer has been yes and has been supported by two types of evidence first studies such as lamont 1997 shin and stulz 1998 shin and park 1998 and rajan servaes and zingales 2000 all find that internal capital markets in conglomerates transfer funds across divisions in a suboptimal manner second studies such as berger and ofek and scharfstein 1998 provide evidence suggesting that the divisions of conglomerates do not respond adequately to investment opportunities in comparison to single segment firms however these findings about divisional investment may be an artifact of measurement error most of these studies rely on tobin s q the market value of the capital stock divided by its replacement value as a proxy for investment opportunities and tobin s q is likely to be a poor proxy shin and stulz

a stochastic dominance comparison of water conserving irrigation strategies stochastic dominance and stochastic dominance with respect to a function are used to compare water conserving irrigation strategies in an area of declining ground water supplies a computerized grain sorghum plant growth model using daily weather observations provides the basis for stochastic dominance comparisons six irrigation strategies dominate contemporary intensive irrigation practices by first degree stochastic dominance and two additional strategies exhibit second degree stochastic dominance over contemporary practices dominant strategies involve irrigating based on a 45 percent soil water criterion and eliminating early season irrigations some dominant strategies reduce water use by as much as 40 percent while increasing expected net returns

the influence of financial and legal institutions on firm size abstract theory does not predict an unambiguous relationship between a country s financial and legal institutions and firm size using data on the largest industrial firms for 44 countries we find that firm size is positively related to financial intermediary development the efficiency of the legal system and property rights protection we do not find any evidence that firms are larger in order to internalize the functions of the banking system or to compensate for the general inefficiency of the legal system

conservation payments under risk a stochastic dominance approach conservation payments can be used to preserve forest and agroforest systems to explain landowners land use decisions and determine appropriate conservation payments it is necessary to focus on revenue risk marginal conditional stochastic dominance rules are used to derive conditions for determining the conservation payments required to guarantee that the environmentally preferred land use dominates an empirical application to shaded coffee protection in the biologically important choco region of west ecuador shows that conservation payments required for preserving shaded coffee areas are much higher than those calculated under risk neutral assumptions further the extant distribution of land has strong impacts on the required payments

the effects of inflation and money supply announcements on interest rates this paper examines the impact of the money supply and inflation rate announcements on interest rates survey data on expectations of the money supply and consumer and producer price indexes are used to distinguish anticipated and unanticipated components of the announcements this distinction is used to test for the efficiency of the financial market response to the announcements of new information the results indicate that the unanticipated components of the announced changes in the producers price index and in the money supply have an immediate positive effect on short term interest rates the consumer price index announcement has no apparent effect there is no evidence of a delayed announcement effect however there is some indication of a liquidity effect of the money supply change on interest rates this takes place when reserves are changing and several weeks prior to the information announcement the effect of money supply announcements on interest rates has attracted considerable attention in both the academic literature and the financial press in the last few years it has been firmly established that unanticipated increases in the money supply lead to immediate increases in interest rates however there are several competing explanations for this phenomenon in the literature in this paper we present some additional empirical evidence which helps to distinguish between two of these hypotheses the policy anticipations and inflationary expectations hypotheses by examining the effect of money supply and inflation announcements on interest rates the positive effect on interest rates of announcements of unanticipated increases in the money supply was demonstrated by urich and wachtel 9 grossman 3 and roley 5 the announcement effect was interpreted in our earlier paper as a policy anticipations effect and has been interpreted by others e g cornell 1 as an inflationary expectations effect since both effects are in the same direction it is difficult to distinguish between them without additional evidence the policy anticipations effect is simply that an unanticipated increase in the money supply causes financial market participants to expect that the federal reserve will tighten the monetary reins in order to offset the increase in anticipation of future tightening there is a tendency for interest rates to increase the inflationary expectations effect is that an unanticipated increase

small firms in economic theory this is the fourth of a series of critical survey articles the aim of the series is to report on recent developments to provide an assessment of alternative approaches and to suggest lines of future inquiry it is intended that the articles will be accessible not only to other academic researchers but also to students and others more practically involved in the economy future survey articles will include warren samuels on institutional economics and philip arestis on post keynesian

ownership changes and access to external financing this paper examines access to external financing in the privatization context and provides new evidence on the effects of financing constraints on performance and investment ownership reforms increase firms reliance on external financing empirically performance and investment changes around ownership reforms are increasing in country level measures of access to credit the presence of a severe prior public financing constraint contributes to stronger investment growth after privatization privatized enterprises do not outperform publicly owned industries all else given our analyses rely on new international sector and firm level data and correct for potential endogeneity of ownership changes

informality and credit constraints evidence from sub saharan african mses abstractthe attributes of micro and small enterprises mses influencing access to credit in particular the level and role of firm informality are analysed in the article the puzzle is the push for mses to join the formal sector and the tug to avoid the extra burden it places on the firm it is important to know more clearly what forces are at work and the sources of the causal effects this study uses data from the world bank enterprise surveys for five low income countries lics in sub saharan africa the method is empirical and as we find informality to be endogenous to credit constraints an instrumental variable approach is estimated further to address the possibility of reverse causality an instrument for the informality variable is required not registered with inland revenue tax office is the chosen instrument variable the findings reveal that as the probability of a firm operating in the formal sector increases there is greater access to external credit the causality relationships are

financial and legal constraints to growth does firm size matter using a unique firm level survey database covering 54 countries we investigate the effect of financial legal and corruption problems on firms growth rates whether these factors constrain growth depends on firm size it is consistently the smallest firms that are most constrained financial and institutional development weakens the constraining effects of financial legal and corruption obstacles and it is again the small firms that benefit the most there is only a weak relation between firms perception of the quality of the courts in their country and firm growth we also provide evidence that the corruption of bank officials constrains firm growth

law finance and firm growth we investigate how differences in legal and financial systems affect firms use of external financing to fund growth we show that in countries whose legal systems score high on an efficiency index a greater proportion of firms use long term external financing an active though not necessarily large stock market and a large banking sector are also associated with externally financed firm growth the increased reliance on external financing occurs in part because established firms in countries with well functioning institutions have lower profit rates government subsidies to industry do not increase the proportion of firms relying on external financing the corporate finance literature suggests that market imperfections caused by conflicts of interest and informational asymmetries between corporate insiders and investors constrain firms in their ability to fund investment projects the magnitude of these imperfections depends in part on the effectiveness of the legal and financial systems because these systems differ across countries the literature implies that there should exist systematic cross country differences in firms ability to obtain external capital to finance investment in this paper we examine whether the underdevelopment of legal and financial systems does prevent firms in some countries from investing in potentially profitable growth opportunities in particular we focus on the use of long term debt or external equity to fund growth see our earlier work demirgut kunt and maksimovic 1996a which compares firms financial structures in developed and developing countries and finds the greatest difference to be in the provision of long term credit we estimate a financial planning model to obtain the maximum growth rate that each firm in our thirty country sample could attain without access to long term financing we then compare these predicted growth rates to growth rates realized by firms in countries with differing degrees of development in their legal and financial systems our approach enables us to identify specific characteristics of the legal and financial systems that are associated with long term financing of firm growth thus we provide a micro level test of the hypoth

a new database on the structure and development of the financial sector this article introduces a new database of indicators of financial structure and financial development across countries and over time the database is unique in that it combines a wide variety of indicators that measure the size activity and efficiency of financial intermediaries and markets it improves on previous efforts by presenting data on the public share of commercial banks introducing indicators of the size and activity of nonbank financial institutions and constructing measures of the size of bond and primary equity markets this article introduces a new database the first to provide comprehensive measures of the development structure and performance of the financial sector this database is the first to define and construct indicators of the size and activity of nonbank financial intermediaries such as insurance companies pension funds and non deposit money banks it is also the first to include indicators of the size of primary equity markets and primary and secondary bond markets in constructing the database authors carefully deflate measures and match stock and flow variables

bank market power and lending during the global financial crisis abstract this research examines how the global financial crisis gfc affected banks supply of credit not only in a direct way but also indirectly through changes in bank market power we use a sample of 735 banks from 17 countries during the 2003 2012 period we find that the direct negative impact of the gfc on banks supply of loans is counteracted by an indirect effect through the increased level of bank market power in the years after the onset of the crisis this result is particularly relevant in countries with less stringent restrictions on bank activities and less supervisory power

investor protection and corporate governance recent research has documented large differences among countries in ownership concentration in publicly traded firms in the breadth and depth of capital markets in dividend policies and in the access of firms to external finance a common element to the explanations of these differences is how well investors both shareholders and creditors are protected by law from expropriation by the managers and controlling shareholders of firms we describe the differences in laws and the effectiveness of their enforcement across countries discuss the possible origins of these differences summarize their consequences and assess potential strategies of corporate governance reform we argue that the legal approach is a more fruitful way to understand corporate governance and its reform than the conventional distinction between bank centered and market centered financial systems

stochastic dominance and expected utility survey and analysis while stochastic dominance has been employed in various forms as early as 1932 it has only been since 1969 1970 that the notion has been developed and extensively employed in the area of economics finance agriculture statistics marketing and operations research in this survey the first second and third order stochastic dominance rules are discussed with an emphasis on the development in the area since the 1980s

access to finance an unfinished agenda recent data compilations show that many poor and non poor people in many developing countries face a high degree of financial exclusion and high barriers in access to finance theory and empirical evidence point to the critical role that improved access to finance has in promoting growth and reducing income inequality an extensive literature shows the channels through which finance promotes enterprise growth and improves aggregate resource allocation there is less evidence at the household level however and on the effectiveness of policies to overcome financial exclusion the article summarizes recent efforts to measure and analyze the impact of access to finance and discusses the unfinished research agenda

prospect theory and mean variance analysis the experimental results of prospect theory pt reveal suggest that investors make decisions based on change of wealth rather than total wealth that preferences are s shaped with a risk seeking segment and that probabilities are subjectively distorted this article shows that while pt s findings are in sharp contradiction to the foundations of mean variance mv analysis counterintuitively when diversification between assets is allowed the mv and pt efficient sets almost coincide thus one can employ the mv optimization algorithm to construct ptefficient portfolios the markowitz 1952a tobin 1958 mean variance mv rule is probably the most popular investment decision rule under uncertainty in economics and in finance and it is widely employed by both academics and practitioners the strength of the mv analysis is that in the case of normal return distributions the choice of any expected utility maximizing risk averse individual will be according to the mv rule 1 the mv framework is the foundation of the sharpe 1964 lintner 1965 capital asset pricing model capm which is a cornerstone of modern finance moreover the mv framework provides a very important practical procedure for the construction of efficient portfolios while standard economic theory and in particular mv analysis assume expected utility maximization and risk aversion in a breakthrough article kahneman and tversky 1979 show that the actual behavior of individuals systematically and consistently violates these

the role of law in economic growth a literature review abstract compared with other explanatory variables such as capital accumulation technological innovations geographical endowments economic openness and cultural factors institutions especially legal institutions have been regarded as a crucial condition for economic growth in recent years the importance of legal rules is systematically revealed by a series of cross country econometric studies conducted by la porta et al who claim that legal origins are central to understanding the divergence in living standards across the regions and countries of the world and compared with civil law countries especially those countries with french civil law tradition common law countries have enjoyed superior economic outcomes the controversies set off by la porta et al s proposition indicate that there are a number of questions that are difficult to explain by la porta et al s theory and hence call for more work on comparative analysis of different legal families before a consensus can be reached

stocks for the log run and constant relative risk aversion preferences abstract almost stochastic dominance implies that stocks are preferred over bonds in the long run by all preferences with bounded marginal utility unfortunately this analysis excludes the very central constant relative risk aversion crra preferences which have unbounded marginal utility we derive a simple closed form solution for the portfolio choice problem of crra investors which with the empirical parameters implies that stocks are preferred over bonds for all crra investors with relative risk aversion smaller than 3 9 as a by product the analysis offers an alternative derivation of the continuous time capm that does not rely on dynamic programming and allows for ambiguous investment horizons

preferred by all and preferred by most decision makers almost stochastic dominance while most decision makers may prefer one uncertain prospect over another stochastic dominance rules as well as other investment criteria will not reveal this preference due to some extreme utility functions in the case of even a very small violation of these rules such strict rules relate to all utility functions in a given class including extreme ones which presumably rarely represents investors preference in this paper we establish almost stochastic dominance asd rules which formally reveal a preference for most decision makers but not for all of them the asd rules reveal that choices which probably conform with most decision makers also solve some debates e g showing as practitioners claim an asd preference for a higher proportion of stocks in the portfolio as the investment horizon increases a conclusion which is not implied by the well known stochastic dominance rules

are internal capital markets efficient using segment information from compustat we find that the investment by a segment of a diversified firm depends on the cash flow of the firm s other segments but significantly less than it depends on its own cash flow the investment by segments of highly diversified firms is less sensitive to their cash flow than the investment of comparable single segment firms the sensitivity of a segment s investment to the cash flow of other segments does not depend on whether its investment opportunities are better than those of the firm s other segments

a note on almost stochastic dominance abstract both the expected utility maximization and the hierarchy property are very important properties in stochastic dominance for almost stochastic dominance leshno and levy 2002 propose a definition and tzeng et al 2013 modified it to give another definition this note provides more information on the two definitions the former has the hierarchy property but not the expected utility maximization whereas the latter has the expected utility maximization but not the hierarchy property

marginal conditional stochastic dominance this paper introduces the concept of marginal conditional stochastic dominance mcsd which states the conditions under which all risk averse individuals when presented with a given portfolio prefer to increase the share of one risky asset over that of another mcsd rules also answer the question of whether all risk averse individuals include a new asset in their portfolio when assets returns are correlated mcsd criteria are expressed in terms of the probability distributions of the assets and of the underlying portfolio an empirical application of mcsd is provided using stocks traded on the new york stock exchange mcsd rules are used to show that in the long run one cannot assert that the market portfolio is inefficient

finance and the sources of growth the authors evaluate whether the level of development in the banking sector exerts a causal impact on economic growth and its sources total factor productivity growth physical capital accumulation and private saving they use 1 a pure cross country instrumental variable estimator to extract the exogenous component of banking development and 2 a new panel technique that controls for country specific effects and endogeneity they find that banks do exert a large causal impact on total factor productivity growth which feeds through to overall gdp gross domestic product growth the long run links between banking development and both capital growth and private savings are more tenuous

small and medium size enterprises access to finance as a growth constraint abstract this paper presents recent research on access to finance by small and medium size enterprises smes smes form a large part of private sector in many developed and developing countries while cross country research sheds doubt on a causal link between smes and economic development there is substantial evidence that small firms face larger growth constraints and have less access to formal sources of external finance potentially explaining the lack of smes contribution to growth financial and institutional development helps alleviate smes growth constraints and increase their access to external finance and thus levels the playing field between firms of different sizes specific financing tools such as leasing and factoring can be useful in facilitating greater access to finance even in the absence of well developed institutions as can systems of credit information sharing and a more competitive banking structure

is small beautiful financial structure size and access to finance combining two unique data sets this paper explores the relationship between the relative importance of different financial institutions and their average size and firms access to financial services specifically the authors explore the relationship between the share in total financial assets and average asset size of banks low end financial institutions and specialized lenders on the one hand and firms access to and use of deposit and lending services on the other hand two findings stand out first the dominance of banks in most developing and emerging markets is associated with lower use of financial services by firms of all sizes low end financial institutions and specialized lenders seem particularly suited to ease access to finance in low income countries second there is no evidence that smaller institutions are better in providing access to finance to the contrary larger specialized lenders and larger banks might actually ease small firms financing constraints but only at low levels of gross domestic product per capita