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Raghuram G. Rajan's
Scholarly Papers
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33,430 |
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4,885 |
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1.
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The Cost of Diversity: The Diversification Discount and Inefficient Investment
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Raghuram G. Rajan University of Chicago - Booth School of Business Henri Servaes London Business School Luigi Zingales University of Chicago Booth School of Business
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05 Feb 98
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22 Apr 08
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5,711 ( 203) |
259
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Raghuram G. Rajan University of Chicago - Booth School of Business Henri Servaes London Business School Luigi Zingales University of Chicago Booth School of Business
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25 May 06
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25 May 06
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32
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In a simple model of capital budgeting in a diversified firm where headquarters has limited power, we show that funds are allocated towards the most inefficient divisions. The distortion is greater the more diverse are the investment opportunities of the firm`s divisions. We test these implications on a panel of diversified firms in the U.S. during the period 1979-1993. We find that i) diversified firms mis-allocate investment funds; ii) the extent of mis-allocation is positively related to the diversity of the investment opportunities across divisions; iii) the discount at which these diversified firms trade is positively related to the extent of the investment mis-allocation and to the diversity of the investment opportunities across divisions.
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Raghuram G. Rajan University of Chicago - Booth School of Business Henri Servaes London Business School Luigi Zingales University of Chicago Booth School of Business
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11 Apr 00
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22 Apr 08
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Abstract:
In a simple model of capital budgeting in a diversified firm where headquarters has limited power, we show that funds are allocated towards the most inefficient divisions The distortion is greater the more diverse are the investment opportunities of the firm's divisions. We test these implications on a panel of diversified firms in the U.S. during the period 1979-1993. We find that i) diversified firms mis-allocate investment funds; ii) the extent of mis-allocation is positively related to the diversity of the investment opportunities across divisions; iii) the discount at which these diversified firms trade is positively related to the extent of the investment mis-allocation and to the diversity of the investment opportunities across divisions.
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Raghuram G. Rajan University of Chicago - Booth School of Business Henri Servaes London Business School Luigi Zingales University of Chicago Booth School of Business
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05 Feb 98
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22 Apr 08
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5,679
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259
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Abstract:
In a simple model of capital budgeting in a diversified firm where headquarters has limited power, we show that funds are allocated towards the most inefficient divisions The distortion is greater the more diverse are the investment opportunities of the firm's divisions. We test these implications on a panel of diversified firms in the U.S. during the period 1979-1993. We find that i) diversified firms mis-allocate investment funds; ii) the extent of mis-allocation is positively related to the diversity of the investment opportunities across divisions; iii) the discount at which these diversified firms trade is positively related to the extent of the investment mis-allocation and to the diversity of the investment opportunities across divisions.
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2.
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Luigi Zingales University of Chicago Booth School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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31 Mar 97
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22 Apr 08
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3,297 (619)
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148
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What determines the boundaries of a firm? Is a firm defined solely by the ownership of physical assets as suggested by the property rights theory? This paper presents a theory of the firm based on the well-known idea that the firm improves over the market because it uses ex ante mechanisms to enhance specific investments. Maintaining the contractability assumptions of the property rights view, however, we identify not one but two such mechanisms. One is, of course, the ownership of property rights. Our contribution here is to highlight the costs of this mechanism which has been underemphasized. The second is the access agents have to the scarce resources, be they physical assets or human capital, that are needed for the production process. The theory enables us to address a number of issues including the separation of ownership and control, the importance of organizational design, and the rationale for the division of labor.
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3.
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Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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15 Aug 98
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03 Mar 10
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3,004 ( 728) |
170
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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25 Jul 00
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03 Mar 10
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51
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Both investors and borrowers are concerned about liquidity. Investors desire liquidity because they are uncertain about when they will want to eliminate their holding of a financial asset. Borrowers are concerned about liquidity because they are uncertain about their ability to continue to attract or retain funding. Because borrowers typically cannot repay investors on demand, investors will require a premium or significant control rights when they lend to borrowers directly, as compensation for the illiquidity investors will be subject to. We argue that banks can resolve these liquidity problems that arise in direct lending. Banks enable depositors to withdraw at low cost, as well as buffer firms from the liquidity needs of their investors. We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions. Far from being an aberration to be regulated away, the funding of illiquid loans by a bank with volatile demand deposits is rationalized in the context of the functions it performs. This model can be used to investigate important issues such as narrow banking and bank capital requirements.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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15 Aug 98
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20 Jul 00
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2,953
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Both investors and borrowers are concerned about liquidity. Investors desire liquidity because they are uncertain about when they will want to eliminate their holding of a financial asset. Borrowers are concerned about liquidity because they are uncertain about their ability to continue to attract or retain funding. We argue that financial intermediation can resolve these liquidity problems that arise in direct lending. Banks enable depositors to withdraw at low cost, as well as buffer firms from the liquidity needs of their investors. We show the bank has to have a somewhat fragile capital structure, subject to bank runs, in order to perform these functions. A number of institutional features of a bank are therefore rationalized in the context of the functions it performs. This model can be used to investigate important issues such as narrow banking, and bank capital requirements.
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4.
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A Theory of Bank Capital
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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09 Jun 99
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25 May 06
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2,482 ( 1,021) |
109
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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25 May 06
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25 May 06
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Banks can create liquidity because their deposits are fragile and prone to runs. Increased uncertainty can make deposits excessively fragile in which case there is a role for outside bank capital. Greater bank capital reduces liquidity creation by the bank but enables the bank to survive more often and avoid distress. A more subtle effect is that banks with different amounts of capital extract different amounts of repayment from borrowers. The optimal bank capital structure trades off the effects of bank capital on liquidity creation, the expected costs of bank distress, and the ease of forcing borrower repayment. The model can account for phenomena such as the decline in average bank capital in the United States over the last two centuries. It points to overlooked side-effects of policies such as regulatory capital requirements and deposit insurance.
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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09 Jun 99
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20 Jul 00
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2,432
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109
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Abstract:
Banks can create liquidity because their deposits are fragile and prone to runs. Increased uncertainty can make deposits excessively fragile in which case there is a role for outside bank capital. Greater bank capital reduces liquidity creation by the bank but enables the bank to survive more often and avoid distress. A more subtle effect is that banks with different amounts of capital extract different amounts of repayment from borrowers. The optimal bank capital structure trades off the effects of bank capital on liquidity creation, the expected costs of bank distress, and the ease of forcing borrower repayment. The model can account for phenomena such as the decline in average bank capital in the United States over the last two centuries, or the nature of disintermediation in liberalizing economies. Finally, it points to overlooked side-effects of policies such as regulatory capital requirements and deposit insurance.
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5.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business Krishna B. Kumar University of Southern California
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03 Sep 99
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22 Apr 08
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2,269 (1,218)
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In this paper we examine data on firm size from Europe to shed light on factors correlated with firm size. In addition to studying broad patterns, we use the data to ask whether it is sufficient to think of the firm as a black box as some theories of the firm that we label "technological" do, or whether we need to be concerned with features such as asset specificity and the process of control that are the focus of "organizational" theories. At the industry level, we find capital-intensive industries, high wage industries, and industries that do a lot of R&D have larger firms. While these results are broadly consistent with both types of theories, we find that at the country level organizational theories fare better - countries that have better institutional development, as measured by the efficiency of their judicial system, have larger firms and, once we correct for institutional development, there is little evidence that richer countries or countries with higher average human capital have larger firms. The study of the effects of interactions between an industry's characteristics and a country's environment on size is perhaps the most novel aspect of this paper, and best allows us to discriminate between theories. A central result is that as the judicial efficiency improves, the difference in size between firms in physical capital intensive industries and those in less capital intensive industries diminishes. Similarly, an improvement in patent protection in a country is associated with an increase in the size of firms in R&D intensive industries. These findings are consistent with "Critical Resource" theories of the firm.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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29 Oct 98
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18 Dec 03
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1,832 (1,880)
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As a result of the Asian crisis, relationship-based systems are now under attack for being inefficient and corrupt. Yet, till recently, they were proposed as an alternative form of capitalism to the arm's length Anglo-Saxon system. What went wrong? This paper suggests that relationship-based systems work well when contracts are poorly enforced and capital scarce. Power relationships substitute for contracts, and can achieve better outcomes than a primitive contractual system. But a relationship-based system suppresses the price system and the signals it provides. As a result, relationship-based systems can misallocate capital when presented with large external capital inflows. Since the external capital comes from arm's length investors who typically have little contractual rights or power in a relationship system, and since these investors are rationally aware of the potential for misallocation, they rationally choose to maintain control over borrowers by keeping their claims short term. Thus, the contact between the two systems creates a fragile hybrid, which while mutually beneficial to relationship borrowers and arm's length investors in normal times, is excessively prone to shocks. The paper suggests that while there may be some short term benefits for these economies to revert to the pure relationship-based system, in the long run they will be held back unless they have the greater disclosure, contract enforcement, and competition of the arm's length system. The current Asian crisis may be the most opportune moment for these economies to effect the transition between systems.
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7.
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The Firm as a Dedicated Hierarchy: A Theory of the Origin and Growth of Firms
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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Posted:
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16 Nov 98
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22 Apr 08
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1,584 ( 2,414) |
89
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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21 Jun 00
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10 Apr 01
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40
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A fundamental problem entrepreneurs face in the formative stages of their businesses is how to provide incentives for employees to protect, rather than steal, the source of organizational rents. We study how the entrepreneur's response to this problem will determine the organization's internal structure, growth, and its eventual size. In particular, our model suggests large, steep hierarchies will predominate in physical capital intensive industries, and these will typically have seniority-based promotion policies. By contrast, flat hierarchies will be seen in human capital intensive industries. These will have up-or-out promotion systems, where experienced managers either become owners or are fired. Furthermore, flat hierarchies will have more distinctive technologies or cultures than steep hierarchies. The model points to some essential differences between organized hierarchies and markets.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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16 Nov 98
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22 Apr 08
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1,544
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In the formative stages of their businesses, entrepreneurs have to provide incentives for employees to protect, rather than steal, the source of organizational rents. We study how the entrepreneur's response to this problem determines the organization'sinternal structure, growth,anditseventualsize. Large, steep hierarchies will predominate in physical-capital in-tensive industries, and will have seniority-based promotion policies. By contrast, at hierarchies will prevail in human-capital intensive industries and will have up-or-out promotion systems. Furthermore, at hierarchies will have more distinctive technologies or cultures than steep hierarchies. The model points to some essential differences between organized hierarchies and markets.
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8.
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The Great Reversals: The Politics of Financial Development in the 20th Century
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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Posted:
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22 Jul 00
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12 Feb 10
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1,470 ( 2,751) |
326
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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03 May 01
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03 May 01
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30
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We show that the development of the financial sector does not change monotonically over time. In particular, we find that by most measures, countries were more financially developed in 1913 than in 1980 and only recently have they surpassed their 1913 levels. This pattern is inconsistent with most recent theories of why cross-country differences in financial development do not track differences in economic development, since these theories are based upon time-invariant factors, such as a country's legal origin. We propose instead an 'interest group' theory of financial development. Incumbents oppose financial development because it breeds competition. The theory predicts that incumbents? opposition will be weaker when an economy allows both cross-border trade and capital flows. This theory can go some way towards accounting for the cross-country differences and the time series variation of financial development.
Financial development, history of equity market, political economy
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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29 Sep 06
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12 Feb 10
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39
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Abstract:
We show that the development of the financial sector does not change monotonically over time. In particular, we find that by most measures, countries were more financially developed in 1913 than in 1980 and only recently have they surpassed their 1913 levels. This pattern is inconsistent with most recent theories of why cross-country differences in financial development do not track differences in economic development, since these theories are based upon time-invariant factors, such as a country's legal origin. We propose instead an 'interest group' theory of financial development. Incumbents oppose financial development because it breeds competition. The theory predicts that incumbents' opposition will be weaker when an economy allows both cross-border trade and capital flows. This theory can go some way in accounting for the cross-country differences and the time series variation of financial development.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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22 Jul 00
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22 Apr 08
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1,401
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Abstract:
Indicators of the development of the financial sector do not improve monotonically over time. In particular, we find that by most measures, countries were more financially developed in 1913 than in 1980 and only recently have they surpassed their 1913 levels. This pattern cannot be explained by structural theories that attribute cross-country differences in financial development to time-invariant factors, such as a country's legal origin or culture. We propose an "interest group" theory of financial development where incumbents oppose financial development because it breeds competition. The theory predicts that incumbents' opposition will be weaker when an economy allows both cross-border trade and capital flows. This theory can go some way in accounting for the cross-country differences and the time series variation of financial development. When we recognize that different kinds of institutional heritages afford different scope for private interests to express themselves, we obtain a synthesis between the structural theories and private interest theory, which is supported by the data.
Corporate Governance, Economic Growth
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9.
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Banks and Markets: The Changing Character of European Finance
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Luigi Zingales University of Chicago Booth School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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27 Mar 03
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18 Sep 08
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1,304 ( 3,409) |
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Luigi Zingales University of Chicago Booth School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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24 Jun 03
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24 Jun 03
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In the last two decades the European financial markets have become more market-oriented. We analyse the economic and political forces that have triggered these changes as well as their likely welfare implications. We also try to assess whether this trend will continue. Based on our analysis, we conjecture that even if Europe might benefit from a continuation of the trend, in the near future political support for it is likely to become much weaker. Furthermore, without serious reforms, the trend is likely to benefit Southern Europe less than Northern Europe.
Finance development, financial markets, banking system
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Luigi Zingales University of Chicago Booth School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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27 Mar 03
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24 Jun 03
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Abstract:
In the last two decades the European financial markets have become more market oriented. We analyze the economic and political forces that have triggered these changes as well as their likely welfare implications. We also try to assess whether this trend will continue. Based on our analysis, we conjecture that even if Europe might benefit from a continuation of the trend, in the near future political support for it is likely to become much weaker. Furthermore, without serious reforms, the trend is likely to benefit Southern Europe less than Northern Europe
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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23 Apr 03
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18 Sep 08
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Abstract:
In the last two decades the European financial markets have become more market oriented. We analyze the economic and political forces that have triggered these changes as well as their likely welfare implications. We also try to assess whether this trend will continue. Based on our analysis, we conjecture that even if Europe might benefit from a continuation of the trend, in the near future political support for it is likely to become much weaker. Furthermore, without serious reforms the trend is likely to benefit Southern Europe less than Northern Europe.
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The Influence of the Financial Revolution on the Nature of Firms
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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Posted:
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12 Feb 01
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22 Apr 08
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1,045 ( 5,023) |
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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10 May 01
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10 May 01
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Major technological, regulatory, and institutional changes have made finance more widely available in recent years, amounting to a bona fide 'financial revolution'. In this article, we focus on the impact the financial revolution has had on the way firms are (or should be) organized and managed, and on the policy consequences.
Corporate governance, financial revolution, theory of the firm
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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24 Mar 01
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05 Oct 01
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Major technological, regulatory, and institutional changes have made finance more widely available in recent years, amounting to a bone fide 'financial revolution'. In this article, we focus on the impact the financial revolution has had on the way firms are (or should be) organized and managed, and on the policy consequences.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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12 Feb 01
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22 Apr 08
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Major technological, regulatory, and institutional changes have made finance more widely available in recent years. The ability of financial institutions to price a variety of exotic instruments, and to assess and spread risks, has increased. More data on potential borrowers is now available, and it is also more timely. Improvements in accounting disclosure have resulted in greater borrower transparency. Deregulation has resulted in greater competition and better prices in financial markets. Finally, regulatory barriers protecting the turf of different kinds of financial institutions have come down, resulting in the emergence of new institutional forms.
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Banks, Short Term Debt and Financial Crises: Theory, Policy Implications and Applications
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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18 Jul 00
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01 Apr 01
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790 ( 7,977) |
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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18 Jul 00
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01 Apr 01
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Short-term borrowing has often been blamed for precipitating financial crises. We argue that while the empirical association between a financial institution's, or country's, short-term borrowing and susceptibility to crises may, in fact, exist, the direction of causality is often precisely the opposite to the one traditionally suggested by commentators. Institutions like banks that want to enhance their ability to provide liquidity and credit to difficult borrowers have to borrow short-term. Similarly countries that have poor disclosure rules and inadequate investor protections, have limited long-term debt capacity, and will find their borrowing becoming increasingly short-term as they finance illiquid investment. Thus it is the increasing illiquidity of the investment being financed (or the deteriorating credit quality of borrowers) that necessitates short-term financing, and causes the susceptibility to crises. In fact, once illiquid investments have been financed, rather than making the system more stable, a ban on short-term financing may precipitate a more severe crisis. Even a priori, a ban is not without adverse consequences policy makers have to trade off the costs of decreased credit creation and investment against the benefits of greater stability. A ban on short-term debt often deals with symptoms rather than underlying causes.
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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31 Aug 00
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08 Sep 00
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759
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Short-term borrowing has often been blamed for precipitating financial crises. We argue that while the empirical association between a financial institution's, or country's, short-term borrowing and susceptibility to crises may, in fact, exist, the direction of causality is often precisely the opposite to the one traditionally suggested by commentators. Institutions like banks that want to enhance their ability to provide liquidity and credit to difficult borrowers have to borrow short-term. Similarly countries that have poor disclosure rules and inadequate investor protections, have limited long-term debt capacity, and will find their borrowing becoming increasingly short-term as they finance illiquid investment. Thus it is the increasing illiquidity of the investment being financed (or the deteriorating credit quality of borrowers) that necessitates short-term financing, and causes the susceptibility to crises. In fact, once illiquid investments have been financed, rather than making the system more stable, a ban on short-term financing may precipitate a more severe crisis. Even a priori, a ban is not without adverse consequences: policy makers have to trade off the costs of decreased credit creation and investment against the benefits of greater stability. A ban on short-term debt often deals with symptoms rather than underlying causes.
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12.
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Does Function Follow Organizational Form? Evidence From the Lending Practices of Large and Small Banks
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Allen N. Berger University of South Carolina - Moore School of Business Nathan H. Miller Economic Analysis Group, USDOJ Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business Jeremy C. Stein Harvard University - Department of Economics
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Posted:
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26 Dec 01
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Last Revised:
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26 Nov 03
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784 ( 8,088) |
204
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Allen N. Berger University of South Carolina - Moore School of Business Nathan H. Miller Economic Analysis Group, USDOJ Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business Jeremy C. Stein Harvard University - Department of Economics
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| Posted: |
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02 Feb 02
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Last Revised:
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22 May 02
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35
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203
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Abstract:
Theories based on incomplete contracting suggest that small organizations may do better than large organizations in activities that require the processing of soft information. We explore this idea in the context of bank lending to small firms, an activity that is typically thought of as relying heavily on soft information. We find that large banks are less willing than small banks to lend to informationally 'difficult' credits, such as firms that do not keep formal financial records. Moreover, controlling for the endogeneity of bank-firm matching, large banks lend at a greater distance, interact more impersonally with their borrowers, have shorter and less exclusive relationships, and do not alleviate credit constraints as effectively. All of this is consistent with small banks being better able to collect and act on soft information than large banks.
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Allen N. Berger University of South Carolina - Moore School of Business Nathan H. Miller Economic Analysis Group, USDOJ Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business Jeremy C. Stein Harvard University - Department of Economics
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| Posted: |
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26 Dec 01
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Last Revised:
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26 Nov 03
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749
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204
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Abstract:
Theories based on incomplete contracting suggest that small organizations may do better than large organizations in activities that require the processing of soft information. We explore this idea in the context of bank lending to small firms, an activity that is typically thought of as relying heavily on soft information. We find that large banks are less willing than small banks to lend to informationally "difficult" credits, such as firms that do not keep formal financial records. Moreover, controlling for the endogeneity of bank-firm matching, large banks lend at a greater distance, interact more impersonally with their borrowers, have shorter and less exclusive relationships, and do not alleviate credit constraints as effectively. All of this is consistent with small banks being better able to collect and act on soft information than large banks.
Functional form, organizational structure, distance, banking, soft information, hard information
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13.
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Does Distance Still Matter? The Information Revolution in Small Business Lending
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Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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26 Apr 00
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Last Revised:
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25 May 06
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678 ( 10,035) |
226
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Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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17 May 03
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Last Revised:
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01 Mar 04
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0
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Abstract:
The distance between small firms and their lenders is increasing, and they are communicating in more impersonal ways. After documenting these systematic changes, we demonstrate they do not arise from small firms locating differently, consolidation in the banking industry, or biases in the sample. Instead, improvements in lender productivity appear to explain our findings. We also find distant firms no longer have to be the highest quality credits, indicating they have greater access to credit. The evidence indicates there has been substantial development of the financial sector, even in areas such as small business lending.
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Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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25 May 06
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Last Revised:
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25 May 06
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38
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226
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Abstract:
The distance between small firms and their lenders in the United States is increasing. Not only are firms choosing more distant lenders, they are also communicating with them in more impersonal ways. After documenting these systematic changes, we demonstrate that they do not stem from small firms locating differently, from simple consolidation in the banking industry, or from biases in the sample. Instead, they seem correlated with improvements in bank productivity. We conjecture that greater, and more timely, availability of borrower credit records, as well as the greater ease of processing these may explain the increased lending at a distance. Consistent with such an explanation, distant firms no longer have to be observably the highest quality credits, suggesting that a wider cross-section of firms can now obtain funding from a particular lender. These findings, we believe, are direct evidence that there has been substantial development of the financial sector in the United States, even in areas such as small business lending that have not been directly influenced by the growth in public markets. From a policy perspective, that small firms now obtain wider access to financing suggests the consolidation of banking services may not raise as strong anti-trust concerns as in the past.
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Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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26 Apr 00
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Last Revised:
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13 Apr 01
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640
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226
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Abstract:
The distance between small firms and their lenders in the United States is increasing. Not only are firms choosing more distant lenders, they are also communicating with them in more impersonal ways. After documenting these systematic changes, we demonstrate that they do not stem from small firms locating differently, from consolidation in the banking industry, or from biases in the sample. Instead, they seem correlated with improvements in bank productivity. We conjecture that greater, and more timely, availability of borrower credit records, as well as the greater ease of processing these, may explain the increased lending at a distance. Consistent with such an explanation, distant firms no longer have to be observably the highest quality credits, suggesting that a wider cross-section of firms can now obtain funding from a particular lender. These findings, we believe, are direct evidence that there has been substantial development of the financial sector, even in areas such as small business lending that have not been directly influenced by the growth in public markets. From a policy perspective, that small firms now obtain wider access to financing suggests the consolidation of banking services may not raise as strong anti-trust concerns as in the past.
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14.
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Banks as Liquidity Providers: An Explanation for the Co-Existence of Lending and Deposit-Taking
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Anil K. Kashyap University of Chicago - Booth School of Business - Economics Raghuram G. Rajan University of Chicago - Booth School of Business Jeremy C. Stein Harvard University - Department of Economics
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Posted:
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23 Mar 99
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Last Revised:
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15 Nov 03
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666 ( 10,316) |
104
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Anil K. Kashyap University of Chicago - Booth School of Business - Economics Raghuram G. Rajan University of Chicago - Booth School of Business Jeremy C. Stein Harvard University - Department of Economics
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| Posted: |
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13 Apr 99
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Last Revised:
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15 Nov 03
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630
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104
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Abstract:
This paper addresses the following question: what ties together the traditional commercial banking activities of deposit-taking and lending? We begin by observing that since banks often lend via commitments, or credit lines, their lending and deposit-taking may be two manifestations of the same primitive function: the provision of liquidity on demand. After all, once the decision to extend a line of credit has been made, it is really nothing more than a checking account with overdraft privileges. This observation leads us to argue that there will naturally be synergies between the two activities, to the extent that both require banks to hold large volumes of liquid assets (cash and securities) on their balance sheets: if deposit withdrawals and commitment takedowns are imperfectly correlated, the two activities can share any deadweight costs of holding the liquid assets. We develop this idea with a simple model, and then use a variety of data to test the model's empirical implications.
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Anil K. Kashyap University of Chicago - Booth School of Business - Economics Raghuram G. Rajan University of Chicago - Booth School of Business Jeremy C. Stein Harvard University - Department of Economics
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| Posted: |
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23 Mar 99
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Last Revised:
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15 Sep 00
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36
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104
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Abstract:
This paper addresses the following question: what ties together the traditional commercial banking activities of deposit-taking and lending? We begin by observing that since banks often lend via commitments, or credit lines, their lending and deposit-taking may be two manifestations of the same primitive function: the provision of liquidity on demand. After all, once the decision to extend a line of credit has been made, it is really nothing more than a checking account with overdraft privileges. This observation leads us to argue that there will naturally be synergies between the two activities, to the extent that both require banks to hold large volumes of liquid assets (cash and securities) on their balance sheets: if deposit withdrawals and commitment takedowns are imperfectly correlated, the two activities can share any deadweight costs of holding the liquid assets. We develop this idea with a simple model, and then use a variety of data to test the model's empirical implications.
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15.
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The Internal Governance of Firms
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Viral V. Acharya New York University - Leonard N. Stern School of Business Stewart C. Myers Massachusetts Institute of Technology (MIT) Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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28 Feb 09
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Last Revised:
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08 Dec 09
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521 ( 14,828) |
5
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Viral V. Acharya New York University - Leonard N. Stern School of Business Stewart C. Myers Massachusetts Institute of Technology (MIT) Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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08 Dec 09
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Last Revised:
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08 Dec 09
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15
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5
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Abstract:
We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. Internal governance can mitigate agency problems and ensure that firms have substantial value, even with little or no external governance by investors. Internal governance works best when both top management and subordinates are important in generating cash flow. External governance, even if crude and uninformed, can complement internal governance and improve efficiency. This leads to a theory of investment and dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Our paper can explain why firms with limited external oversight, and firms in countries with poor external governance, can have substantial value.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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Viral V. Acharya New York University - Leonard N. Stern School of Business Stewart C. Myers Massachusetts Institute of Technology (MIT) Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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07 Apr 09
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Last Revised:
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07 Apr 09
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2
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5
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Abstract:
We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. We find that internal governance can mitigate agency problems and ensure firms have substantial value, even without any external governance. Internal governance seems to work best when both top management and subordinates are important to value creation. We then allow for governance provided by external financiers and show that external governance, even if crude and uninformed, can complement internal governance in improving efficiency. Interestingly, this leads us to a theory of investment and dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Finally, we explore how the internal organization of firms may be structured to enhance the role of internal governance. Our paper could explain why firms with limited external oversight, and firms in countries with poor external governance, can have substantial value.
Agency theory, Corporate governance, Dividends, Internal organization, Short-termism
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Viral V. Acharya New York University - Leonard N. Stern School of Business Stewart C. Myers Massachusetts Institute of Technology (MIT) Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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09 Mar 09
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Last Revised:
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01 Dec 09
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142
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5
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Abstract:
We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. Internal governance can mitigate agency problems and ensure that firms have substantial value, even with little or no external governance by investors. Internal governance works best when both top management and subordinates are important in generating cash flow. External governance, even if crude and uninformed, can complement internal governance and improve efficiency. This leads to a theory of investment and dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Our paper can explain why firms with limited external oversight, and firms in countries with poor external governance, can have substantial value.
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Viral V. Acharya New York University - Leonard N. Stern School of Business Stewart C. Myers Massachusetts Institute of Technology (MIT) Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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28 Feb 09
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Last Revised:
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01 Dec 09
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362
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5
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Abstract:
We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. Internal governance can mitigate agency problems and ensure that firms have substantial value, even with little or no external governance by investors. Internal governance works best when both top management and subordinates are important in generating cash flow. External governance, even if crude and uninformed, can complement internal governance and improve efficiency. This leads to a theory of investment and dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Our paper can explain why firms with limited external oversight, and firms in countries with poor external governance, can have substantial value.
Agency theory, short-termism, corporate governance, dividends, internal organization
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16.
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The Flattening Firm: Evidence from Panel Data on the Changing Nature of Corporate Hierarchies
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Raghuram G. Rajan University of Chicago - Booth School of Business Julie M. Wulf Harvard Business School
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Posted:
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19 Apr 03
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Last Revised:
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24 Jun 08
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465 ( 17,251) |
65
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Raghuram G. Rajan University of Chicago - Booth School of Business Julie M. Wulf Harvard Business School
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| Posted: |
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19 Apr 03
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Last Revised:
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29 Apr 03
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77
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65
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Abstract:
Using a detailed database of managerial job descriptions, reporting relationships, and compensation structures in over 300 large U.S. firms we find that the number of positions reporting directly to the CEO has gone up significantly over time. We also find that the number of levels between the lowest managers with profit center responsibility (division heads) and the CEO has decreased and more of these managers are reporting directly to the CEO. Moreover, more of these managers are being appointed officers of the company. It does not seem that divisional heads are handling larger tasks making them important enough to report directly. Instead, our findings suggest that layers of intervening management are being eliminated and the CEO is coming into direct contact with more managers in the organization, even while managerial responsibility is being extended downwards. Consistent with this, we find that the elimination of the intermediate position of Chief Operating Officer accounts for a significant part (but certainly not all) of the increase in CEO reports. It is also accompanied with greater authority being given to divisional managers. The structure of pay is also different in flatter organizations. Pay and long term incentives are becoming more like that in a partnership. Salary and bonus at lower levels are lower than in comparable positions in a tall organization, but the pay differential is steeper to the top. At the same time, employees in flatter organizations seem to have more long term pay incentives like stock and stock options offered to them. Drawing on theories, we offer some conjectures to explain these patterns.
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Raghuram G. Rajan University of Chicago - Booth School of Business Julie M. Wulf Harvard Business School
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| Posted: |
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07 May 03
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Last Revised:
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24 Jun 08
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388
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65
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Abstract:
Using a detailed database of managerial job descriptions, reporting relationships, and compensation structures in over 300 large U.S. firms, we find that firm hierarchies are becoming flatter. The number of positions reporting directly to the CEO has gone up significantly over time while the number of levels between the division heads and the CEO has decreased. More of these managers now report directly to the CEO and more are being appointed officers of the firm, reflecting a delegation of authority. Moreover, division managers who move closer to the CEO receive higher pay and greater long term incentives, suggesting that all this is not simply a change in organizational charts with no real consequences. Importantly, flattening cannot be characterized simply as centralization or decentralization. We discuss several possible explanations that may account for some of these changes.
firm, hierarchy, span of control
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17.
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Liquidity Shortages and Banking Crises
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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07 Nov 03
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Last Revised:
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02 Jan 04
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443 ( 18,384) |
75
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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07 Nov 03
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Last Revised:
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24 Nov 03
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16
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75
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Abstract:
We show in this paper that bank failures can be contagious. Unlike earlier work where contagion stems from depositor panics or ex ante contractual links between banks, we argue bank failures can shrink the common pool of liquidity, creating or exacerbating aggregate liquidity shortages. This could lead to a contagion of failures and a possible total meltdown of the system. Given the costs of a meltdown, there is a possible role for government intervention. Unfortunately, liquidity problems and solvency problems interact and can cause each other, making it hard to determine the root cause of a crisis from observable factors. We propose a robust sequence of intervention.
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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02 Jan 04
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Last Revised:
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02 Jan 04
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427
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75
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Abstract:
We show in this paper that bank failures can be contagious. Unlike earlier work where contagion stems from depositor panics or ex ante contractual links between banks, we argue bank failures can shrink the common pool of liquidity, creating or exacerbating aggregate liquidity shortages. This could lead to a contagion of failures and a possible total meltdown of the system. Given the costs of a meltdown, there is a possible role for government intervention. Unfortunately, liquidity problems and solvency problems interact and can cause each other, making it hard to determine the root cause of a crisis from observable factors. We propose a robust sequence of intervention.
Liquidity, Crises, Banking
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18.
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Money in a Theory of Banking
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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15 Dec 03
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Last Revised:
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22 Feb 05
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418 ( 19,894) |
29
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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22 Feb 05
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Last Revised:
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22 Feb 05
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25
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29
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Abstract:
We explore the connection between money, banks, and aggregate credit. We start with a simple 'real' model without money, where banks make loans repayable in goods and depositors hold claims on the bank payable on demand in goods. Aggregate production may be delayed in the economy. If so, we show that the level of ongoing bank lending, and hence of aggregate future output, can decrease with increases in the real repayment due on deposits: ceteris paribus, the higher the amount due, the more likely there will be insufficient goods, given the delay, to pay depositors, and the more new lending has to be curtailed to make up the shortfall. Thus a temporary delay in production can be exacerbated by banks into a more permanent reduction of total output. A number of inefficiencies including bank failures can result if deposits turn out to be too high. We then introduce money in this model. We show that if demand deposits are repayable in money rather than in goods, banks can be hedged against production delays: under certain circumstances, the price level will rise with delays in production, reducing the real value of the deposits banks have to pay out. But demand deposits payable in money can expose the banks to new risks: the value of money can fluctuate for reasons other than delays in aggregate production. Because deposits are convertible into money on demand, a temporary rise in money demand immediately boosts the interest rate banks have to pay depositors, which in turn boosts the real amounts banks have to repay them. This increase in the real deposit burden can again lead to the curtailment of bank lending and even bank failures. The way to combat these contractionary effects is to infuse more money into the banking system. Our analysis thus makes transparent how changes in the supply of money can work through banks to affect real economic activity, without invoking sticky prices, reserve requirements, or deposit insurance. It also suggests how bank failures could lead to a fall in prices and a contagion of bank failures, as described by Friedman and Schwartz (1963).
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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15 Dec 03
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Last Revised:
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15 Dec 03
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393
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29
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Abstract:
We explore the connection between money, banks, and aggregate credit. We start with a simple 'real' model without money, where banks make loans repayable in goods and depositors hold claims on the bank payable on demand in goods. Aggregate production may be delayed in the economy. If so, we show that the level of ongoing bank lending, and hence of aggregate future output, can decrease with increases in the real repayment due on deposits: ceteris paribus, the higher the amount due, the more likely there will be insufficient goods, given the delay, to pay depositors, and the more new lending has to be curtailed to make up the shortfall. Thus a temporary delay in production can be exacerbated by banks into a more permanent reduction of total output. A number of inefficiencies including bank failures can result if deposits turn out to be too high. We then introduce money in this model. We show that if demand deposits are repayable in money rather than in goods, banks can be hedged against production delays: under certain circumstances, the price level will rise with delays in production, reducing the real value of the deposits banks have to pay out. But demand deposits payable in money can expose the banks to new risks: the value of money can fluctuate for reasons other than delays in aggregate production. Because deposits are convertible into money on demand, a temporary rise in money demand immediately boosts the interest rate banks have to pay depositors, which in turn boosts the real amounts banks have to repay them. This increase in the real deposit burden can again lead to the curtailment of bank lending and even bank failures. The way to combat these contractionary effects is to infuse more money into the banking system. Our analysis thus makes transparent how changes in the supply of money can work through banks to affect real economic activity, without invoking sticky prices, reserve requirements, or deposit insurance. It also suggests how bank failures could lead to a fall in prices and a contagion of bank failures, as described by Friedman and Schwartz (1963).
Liquidity, Money, Monetary Policy, Banking
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19.
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Luigi Zingales University of Chicago Booth School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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17 Jun 98
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Last Revised:
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22 Mar 00
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407 (20,552)
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5
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Abstract:
There are many instances where two closely related parties do not agree to mutually advantageous transactions even when there are simple enforceable contracts, and side transfers of fungible resources, that would implement them. Peace treaties are not signed, inefficient regulations are not altered, and possibilities for investment are frittered away. One reason, which has been extensively analyzed in the literature, is the presence of informational asymmetries. In this paper we focus on another potential explanation: the externality generated by the transfer of fungible resources. Unlike in a one-off transaction among unrelated parties, related parties will interact in the future. The very fungibility of the resources that are transferred to facilitate the immediate transaction can make it hard to restrict their use. As a result, if future interactions are influenced by the distribution of current resources, an externality can endogenously arise from the current transaction. Under some circumstances, even transactions that considerably enhance value can be inhibited by the endogenous externality. Agreement typically breaks down when the required transfer is large and the proposed recipient of the transfer is relatively unproductive or poor. The paper examines the implications for a theory of property rights, and for competitive strategy.
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20.
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Business Environment and Firm Entry: Evidence from International Data
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Leora F. Klapper World Bank Luc A. Laeven International Monetary Fund (IMF) Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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01 Apr 04
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Last Revised:
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23 May 05
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361 ( 23,913) |
35
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Leora F. Klapper World Bank Luc A. Laeven International Monetary Fund (IMF) Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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23 Jun 04
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Last Revised:
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23 May 05
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313
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35
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Abstract:
Using a comprehensive database of firms in Western and Eastern Europe, we study how the business environment in a country drives the creation of new firms. Our focus is on regulations governing entry. We find entry regulations hamper entry, especially in industries that naturally should have high entry. Also, value added per employee in naturally "high entry" industries grows more slowly in countries with onerous regulations on entry. The consequences of more restrictive entry barriers are seen, not in young firms, but in older firms, who grow more slowly and to a smaller size. Thus the absence of the disciplining effect of entry has real adverse effects. Interestingly, regulatory entry barriers have no adverse effect on entry in corrupt countries, only in less corrupt ones. Taken together, the evidence suggests bureaucratic entry regulations are neither benign nor welfare improving. However, not all regulations inhibit entry. In particular, regulations that enhance the enforcement of intellectual property rights or those that lead to a better developed financial sector do lead to greater entry in industries that do more R&D or industries that need more external finance.
Entry, Regulations
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Leora F. Klapper World Bank Luc A. Laeven International Monetary Fund (IMF) Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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26 May 04
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Last Revised:
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27 May 04
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18
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35
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Abstract:
Using a comprehensive database of firms in Western and Eastern Europe, we study how the business environment in a country drives the creation of new firms. Our focus is on regulations governing entry. We find entry regulations hamper entry, especially in industries that naturally should have high entry. Also, value-added per employee in naturally 'high entry' industries grows more slowly in countries with onerous regulations on entry. Interestingly, regulatory entry barriers have no adverse effect on entry in corrupt countries, only in less corrupt ones. Taken together, the evidence suggests bureaucratic entry regulations are neither benign nor welfare improving. Not all regulations inhibit entry, however. In particular, regulations that enhance the enforcement of intellectual property rights or those that lead to a better developed financial sector do lead to greater entry in industries that do more R&D or industries that need more external finance.
Business entry, regulation
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Leora F. Klapper World Bank Luc A. Laeven International Monetary Fund (IMF) Raghuram G. Rajan University of Chicago - Booth School of Business
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01 Apr 04
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26 May 04
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30
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35
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Using a comprehensive database of firms in Western and Eastern Europe, we study how the business environment in a country drives the creation of new firms. Our focus is on regulations governing entry. We find entry regulations hamper entry, especially in industries that naturally should have high entry. Also, value added per employee in naturally "high entry" industries grows more slowly in countries with onerous regulations on entry. Interestingly, regulatory entry barriers have no adverse effect on entry in corrupt countries, only in less corrupt ones. Taken together, the evidence suggests bureaucratic entry regulations are neither benign nor welfare improving. However, not all regulations inhibit entry. In particular, regulations that enhance the enforcement of intellectual property rights or those that lead to a better developed financial sector do lead to greater entry in industries that do more R&D or industries that need more external finance.
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21.
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The Tyranny of Inequality
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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Posted:
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18 Apr 00
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22 Apr 08
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325 ( 27,174) |
28
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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06 Jan 01
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22 Apr 08
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0
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When parties are very unequally endowed, agreement may be very difficult to reach, even if the specific transaction is easy to contract on, and fungible resources can be transferred to compensate the losing party. The very fungibility of the transferred resource makes it hard to restrict its use, and changes the amount the parties involved spend in trying to grab future rents. This spill-over effect can inhibit otherwise valuable transactions, as well as enable otherwise inefficient transactions. Agreement typically breaks down when the required transfer is large and the proposed recipient of the transfer is relatively unproductive or poorly endowed. We examine the implications of this model for a theory of the optimal allocation of property rights.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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18 Apr 00
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22 Apr 08
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325
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This paper focuses on the externality that a contractual transfer of fungible resources can have on future interactions. The very fungibility of the resource transferred make it hard to restrict its use, changing the amount the parties involved spend in trying to grab future rents. This spill-over effect can inhibit otherwise valuable transactions, as well as enable otherwise ineffcient transactions. Agreement typically breaks down when the required transfer is large and the proposed recipient of the transfer is relatively unproductive or poorly endowed. We examine the implications of this model for a theory of the optimal allocation of property rights.
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22.
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Organization Structure and Credibility: Evidence from Commercial Bank Securities Activities before the Glass-Steagall Act
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Randall S. Kroszner U.S. Council of Economic Advisors Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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07 Dec 97
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19 Mar 08
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305 ( 29,316) |
44
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Randall S. Kroszner U.S. Council of Economic Advisors Raghuram G. Rajan University of Chicago - Booth School of Business
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19 Jul 00
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19 Mar 08
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25
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This paper investigates how organizational structure can affect a firm's ability to compete. In particular, we examine the two ways in which U.S. commercial banks organized their investment banking operations before the 1933 Glass-Steagall Act forced the banks to leave the securities business: as an internal securities department within the bank and as a separately incorporated and capitalized securities affiliate. We document a strong movement toward the use of the affiliate structure during the 1920s, and regulation does not appear to explain this evolution. While departments underwrote seemingly higher quality firms and securities than did comparable affiliates, the departments obtained lower prices for the issues they underwrote. This evidence is consistent with the hypothesis that there was a perception of potential conflicts of interest when lending and underwriting were closely combined in the departmental structure. We find evidence that bank managers during this period were concerned about such perceptions. We then develop further tests to support the view that by distancing underwriting activities from lending operations, banks could more credibly certify the quality of the issues they underwrote, thereby obtaining higher prices for them. Our results suggest that internal organization may indeed affect the activities and effectiveness of a firm. They also suggest that bank regulators' interest in 'firewalls' between commercial and investment banking may be reasonable, but that the market may propel banks to adopt an internal structure that would address regulators' concerns.
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Randall S. Kroszner U.S. Council of Economic Advisors Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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09 May 98
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07 Mar 01
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0
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The following is a description of the paper, and not the actual abstract: This paper investigates empirically whether the internal organization of the firm can play an important role in affecting a firm's ability to commit to a particular quality of business practices and, if so, whether competition would be sufficient to lead firms to adopt that structure. In particular, we study how commercial banks have developed "firewalls" to address potential conflicts of interest when they are also engaged in investment banking. Before the 1933 Glass-Steagall Act forced banks out of investment banking, commercial banks organized their securities activities in two ways: as an internal securities department within the bank and as a separately incorporated affiliate with its own board of directors. Although the internal departments underwrote seemingly higher quality firms and securities than did comparable affiliates, the departments obtained lower prices for the issues they underwrote. The greater risk premium associated with the internal department is consistent with investors discounting for the greater likelihood of conflicts of interest when lending and underwriting are within the same structure. Commercial banks responded to this pricing disadvantage for the internal departments by moving strongly toward adopting the separate affiliate structure during the period. We find that increasing the proportion of affiliate directors who are independent from the parent bank reduced the risk premium for the securities underwritten by the affiliate. Independent directors thus appear to have provided an important mechanism by which the affiliates could enhance their credibility in the market. Overall, our results suggest that organizational design can be an effective commitment device and, absent other distortions, competitive pressures would provide sufficient incentives for banks to adopt an organizational design that would address regulatory concerns about potential conflicts of interest.
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Randall S. Kroszner U.S. Council of Economic Advisors Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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07 Dec 97
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Last Revised:
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21 Apr 98
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280
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44
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Abstract:
We examine the two ways in which U.S. commercial banks organized their investment banking operations before the 1933 Glass-Steagall Act forced the banks to leave the securities business: as an internal securities department within the bank and as a separately incorporated affiliate with its own board of directors. While departments underwrote seemingly higher quality firms and securities than did comparable affiliates, the departments obtained lower prices for the issues they underwrote. The higher risk premium associated with the internal department is consistent with investors discounting for the greater likelihood of conflicts of interest when lending and underwriting are within the same structure. As a result, commercial banks evolved toward choosing the separate affiliate structure. Our results suggest that internal structure is an effective commitment mechanism, and absent other distortions, market pressures would propel banks to adopt an internal structure that would address regulators' concerns about conflicts of interest.
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23.
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What Undermines Aid`s Impact on Growth?
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Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF)
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Posted:
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03 Mar 06
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31 Jul 06
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268 ( 33,980) |
65
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Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF)
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03 Mar 06
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03 Mar 06
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237
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We examine one of the most important and intriguing puzzles in economics: why it is so hard to find a robust effect of aid on the long-term growth of poor countries, even those with good policies. We look for a possible offset to the beneficial effects of aid, using a methodology that exploits both cross-country and within-country variation. We find that aid inflows have systematic adverse effects on a country`s competitiveness, as reflected in a decline in the share of labor intensive and tradable industries in the manufacturing sector. We find evidence suggesting that these effects stem from the real exchange rate overvaluation caused by aid inflows. By contrast, private-to-private flows like remittances do not seem to create these adverse effects. We offer an explanation why and conclude with a discussion of the policy implications of these findings.
Aid, Growth, Competitiveness
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Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF)
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| Posted: |
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31 Jul 06
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31 Jul 06
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31
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65
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Abstract:
We examine one of the most important and intriguing puzzles in economics: why it is so hard to find a robust effect of aid on the long-term growth of poor countries, even those with good policies. We look for a possible offset to the beneficial effects of aid, using a methodology that exploits both cross-country and within-country variation. We find that aid inflows have systematic adverse effects on a country`s competitiveness, as reflected in a decline in the share of labor intensive and tradable industries in the manufacturing sector. We find evidence suggesting that these effects stem from the real exchange rate overvaluation caused by aid inflows. By contrast, private-to-private flows like remittances do not seem to create these adverse effects. We offer an explanation why and conclude with a discussion of the policy implications of these findings.
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24.
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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21 Feb 09
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19 Mar 10
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252 (36,385)
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18
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Abstract:
What caused the financial crisis that is sweeping across the world? What keeps asset prices and lending depressed? What can be done to remedy matters? While it is too early to arrive at definite answers to these questions, it is certainly time to offer informed conjectures, and these are the focus of this paper.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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25.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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04 Sep 06
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Last Revised:
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22 Apr 08
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244 (37,757)
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17
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Abstract:
Why is underdevelopment so persistent? One explanation is that poor countries do not have institutions that can support growth. Because institutions (both good and bad) are persistent, underdevelopment is persistent. An alternative view is that underdevelopment comes from poor education. Neither explanation is fully satisfactory, the first because it does not explain why poor economic institutions persist even in fairly democratic but poor societies, and the second because it does not explain why poor education is so persistent. This paper tries to reconcile these two views by arguing that the underlying cause of underdevelopment is the initial distribution of factor endowments. Under certain circumstances, this leads to self-interested constituencies that, in equilibrium, perpetuate the status quo. In other words, poor education policy might well be the proximate cause of underdevelopment, but the deeper (and more long lasting cause) are the initial conditions (like the initial distribution of education) that determine political constituencies, their power, and their incentives. Though the initial conditions may well be a legacy of the colonial past, and may well create a perverse political equilibrium of stagnation, persistence does not require the presence of coercive political institutions. We present some suggestive empirical evidence. On the one hand, such an analysis offers hope that the destiny of societies is not preordained by the institutions they inherited through historical accident. On the other hand, it suggests we need to understand better how to alter factor endowments when societies may not have the internal will to do so.
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26.
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Kalpana Kochhar International Monetary Fund (IMF) Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF) Ioannis Tokatlidis International Monetary Fund (IMF)
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| Posted: |
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03 Mar 06
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Last Revised:
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31 May 06
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212 (43,745)
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23
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Abstract:
India has followed an idiosyncratic pattern of development, certainly compared with other fast-growing Asian economies. While the importance of services rather than manufacturing is widely noted, within manufacturing India has emphasized skill-intensive rather than labor-intensive manufacturing, and industries with higher-than-average scale. Some of these distinctive patterns existed prior to the beginning of economic reforms in the 1980s, and stem from the idiosyncratic policies adopted after India's independence. Using the growth of fast-moving Indian states as a guide, we conclude that India may not revert to the pattern followed by other countries, despite reforms that have removed some policy impediments that contributed to India's distinctive path.
Manufacturing, Services, Diversification, Decentralization, Liberalization, Labor Intensity, Skill Intensity, Scale
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27.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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05 Nov 96
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13 May 00
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201 (46,211)
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727
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Abstract:
Does finance affect economic growth? A number of studies have identified a positive correlation between the level of development of a country's financial sector and the rate of growth of its per capita income. As has been noted elsewhere, the observed correlation does not necessarily imply a causal relationship. This paper examines whether financial development facilitates economic growth by scrutinizing one rationale for such a relationship; that financial development reduces the costs of external finance to firms. Specifically, we ask whether industrial sectors that are relatively more in need of external finance develop disproportionately faster in countries with more developed financial markets. We find this to be true in a large sample of countries over the 1980s. We show this result is unlikely to be driven by omitted variables, outliers, or reverse causality.
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28.
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Aid and Growth: What Does the Cross-Country Evidence Really Show?
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Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF)
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Posted:
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03 Mar 06
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Last Revised:
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05 Jan 07
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200 ( 46,430) |
73
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Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF)
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| Posted: |
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03 Mar 06
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11 May 06
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105
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73
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Abstract:
We examine the effects of aid on growth - in cross-sectional and panel data - after correcting for the bias that aid typically goes to poorer countries, or to countries after poor performance. Even after this correction, we find little robust evidence of a positive (or negative) relationship between aid inflows into a country and its economic growth. We also find no evidence that aid works better in better policy or geographical environments, or that certain forms of aid work better than others. Our findings, which relate to the past, do not imply that aid cannot be beneficial in the future. But they do suggest that for aid to be effective in the future, the aid apparatus will have to be rethought. Our findings raise the question: what aspects of aid offset what ought to be the indisputable growth enhancing effects of resource transfers? Thus, our findings support efforts under way at national and international levels to understand and improve aid effectiveness.
Aid and Growth, Cross-Sectional and Panel data
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Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF)
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| Posted: |
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31 Jul 06
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Last Revised:
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05 Jan 07
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95
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73
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Abstract:
We examine the effects of aid on growth--in cross-sectional and panel data--after correcting for the bias that aid typically goes to poorer countries, or to countries after poor performance. Even after thiscorrection, we find little robust evidence of a positive (or negative) relationship between aid inflows into a country and its economic growth. We also find no evidence that aid works better in better policy or geographical environments, or that certain forms of aid work better than others. Our findings, which relate to the past, do not imply that aid cannot be beneficial in the future. But they do suggest that for aid to be effective in the future, the aid apparatus will have to be rethought. Our findings raise the question: what aspects of aid offset what ought to be the indisputable growth enhancing effects of resource transfers? Thus, our findings support efforts under way at national and international levels to understand and improve aid effectiveness.
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29.
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Eswar S. Prasad Cornell University Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF)
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| Posted: |
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04 Dec 07
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Last Revised:
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04 Dec 07
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185 (50,210)
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62
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Abstract:
We document the recent phenomenon of uphill flows of capital from nonindustrial to industrial countries and analyze whether this pattern of capital flows has hurt growth in nonindustrial economies that export capital. Surprisingly, we find that there is a positive correlation between current account balances and growth among nonindustrial countries, implying that a reduced reliance on foreign capital is associated with higher growth. This result is weaker when we use panel data rather than cross-sectional averages over long periods of time, but in no case do we find any evidence that an increase in foreign capital inflows directly boosts growth. What explains these results, which are contrary to the predictions of conventional theoretical models? We provide some evidence that even successful developing countries have limited absorptive capacity for foreign resources, either because their financial markets are underdeveloped, or because their economies are prone to overvaluation caused by rapid capital inflows.
North-South capital flows, financial globalization
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30.
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Eswar S. Prasad Cornell University Raghuram G. Rajan University of Chicago - Booth School of Business
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05 Sep 06
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14 Jan 07
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175 (53,061)
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6
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Abstract:
China has achieved tremendous economic progress in the last three decades, but there is much work to be done to make the economy resilient to large shocks, ensure the sustainability of its growth, and translate this growth into corresponding improvements in the economic welfare of its citizens. We discuss the complex challenges that Chinese policymakers face in striking the right balance in terms of speed and coordination of reforms. We argue that China's current stage of development, along with its rising market orientation and increasing integration with the world economy, may make the incremental and piecemeal approaches to reforms increasingly untenable and, in some cases, could even generate risks of their own. The present favorable domestic and external circumstances provide an excellent window of opportunity for bolder reforms and for tackling some deep-rooted problems without causing much economic disruption.
policy reforms, market-oriented economy, trade and financial integration
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31.
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Landed Interests and Financial Underdevelopment in the United States
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Raghuram G. Rajan University of Chicago - Booth School of Business Rodney Ramcharan International Monetary Fund (IMF) - Research Department
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Posted:
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11 Sep 08
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02 Oct 08
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167 ( 55,552) |
1
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Raghuram G. Rajan University of Chicago - Booth School of Business Rodney Ramcharan International Monetary Fund (IMF) - Research Department
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| Posted: |
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23 Sep 08
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02 Oct 08
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14
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1
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Abstract:
Landed elites in the United States in the early decades of the twentieth century played a significant role in restricting the development of finance. States that had higher land concentration passed more restrictive banking legislation. At the county level, counties with very concentrated land holdings tended to have disproportionately fewer banks per capita. Banks were especially scarce both when landed elites' incentive to suppress finance, as well as their ability to exercise local influence, was higher. Finally, the resulting financial underdevelopment was negatively correlated with subsequent manufacturing growth. We draw lessons from this episode for understanding economic development.
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Raghuram G. Rajan University of Chicago - Booth School of Business Rodney Ramcharan International Monetary Fund (IMF) - Research Department
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| Posted: |
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11 Sep 08
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Last Revised:
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11 Sep 08
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153
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1
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Abstract:
Landed elites in the United States in the early decades of the twentieth century played a significant role in restricting the development of finance. States that had higher land concentration passed more restrictive banking legislation. At the county level, counties with very concentrated land holdings tended to have disproportionately fewer banks per capita.
Banks were especially scarce both when landed elites' incentive to suppress finance, as well as their ability to exercise local influence, was higher. Finally, the resulting financial underdevelopment was negatively correlated with subsequent manufacturing growth. We draw lessons from this episode for understanding economic development.
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32.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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11 Oct 00
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Last Revised:
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05 Oct 01
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130 (69,598)
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68
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Abstract:
The changing nature of the corporation forces us to re-examine much of what we take for granted in corporate governance. What precisely is the entity that is being governed? How does the governance system obtain power over it, and what determines the division of power between various stakeholders? And is the objective of allocating power only to enhance the returns of outside investors? In this paper we argue that, given the changing nature of the firm, the focus of corporate governance must shift from alleviating the agency problems between managers and shareholders to studying mechanisms that give the firm the power to provide incentives to human capital. We also provide some examples of the kind of subjects that should now be the main focus of study in corporate governance.
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33.
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The Persistence of Underdevelopment: Constituencies and Competitive Rent Preservation
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Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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14 May 06
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Last Revised:
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05 Apr 07
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120 ( 74,401) |
19
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Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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05 Apr 07
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Last Revised:
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05 Apr 07
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87
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14
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Abstract:
Why is underdevelopment so persistent? I argue that one reason is the initial inequality in endowments and opportunities, which leads to self-interested constituencies that perpetuate the status quo. Each constituency prefers reforms that preserve only its rents and expand its opportunities, so no comprehensive reform path may command broad support. Though the initial conditions may well be a legacy of the colonial past, persistence does not require the presence of coercive political institutions. This may be why underdevelopment has survived independence and democratization. On the one hand, such an analysis offers hope that the destiny of societies is not preordained by the political institutions they inherit through historical accident. On the other hand, it suggests we need to understand better how to alter factor endowments when societies may not have the internal will to do so.
Underdevelopment, persistence, factor endowment, constituency
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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14 May 06
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Last Revised:
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22 May 06
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33
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13
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Abstract:
Initial inequality in endowments and opportunities, together with low average levels of endowments, can create constituencies in a society that combine to paralyze reforms, even though the status quo hurts them collectively. Each constituency prefers reforms that expand its opportunities, but in an unequal society, this will typically hurt another constituencys rents. Competitive rent preservation ensures no comprehensive reform path may command broad support. Though the initial conditions may well be a legacy of the colonial past, persistence does not require the presence of coercive political institutions, perhaps one reason why underdevelopment has survived independence and democratization. Instead, the roots of underdevelopment may lie in the natural tendency towards rent preservation in a divided society.
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34.
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What Do We Know About Capital Structure? Some Evidence from International Data
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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Posted:
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10 Nov 95
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Last Revised:
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21 Apr 08
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105 ( 82,454) |
565
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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10 Jun 00
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Last Revised:
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21 Apr 08
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105
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565
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Abstract:
We investigate the determinants of capital structure choice by analyzing the financing decisions of public firms in the major industrialized countries. At an aggregate level, firm leverage is fairly similar across the G-7 countries. We find that factors identified by previous studies as important in determining the cross- section of capital structure in the U.S. affect firm leverage in other countries as well. However, a deeper examination of the U.S. and foreign evidence suggests that the theoretical underpinnings of the observed correlations are still largely unresolved.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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10 Nov 95
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Last Revised:
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11 Feb 98
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0
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Abstract:
We investigate the determinants of capital structure choice by analyzing the financing decisions of public firms in the major industrialized countries. At an aggregate level, firm leverage is fairly similar across the G-7 countries. We find that factors identified by previous studies as correlated in the cross-section with firm leverage in the U.S., are similarly correlated in other countries as well. However, a deeper examination of the U.S. and foreign evidence suggests that the theoretical underpinnings of the observed correlations are still largely unresolved.
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35.
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Trade Credit: Theories and Evidence
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Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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22 Aug 98
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Last Revised:
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25 Mar 08
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102 ( 84,274) |
117
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Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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11 Jun 00
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Last Revised:
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25 Mar 08
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102
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117
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Abstract:
In addition to borrowing from financial institutions, firms may be financed by their suppliers. Although there are many theories explaining why non-financial firms lend money, there are few comprehensive empirical tests of these theories. This paper attempts to fill the gap. We focus on a sample of small firms whose access to capital markets may be limited. We find evidence that firms use trade credit relatively more when credit from financial institutions is not available. Thus while short term trade credit may be routinely used to minimize transactions costs, medium term borrowing against trade credit is a form of financing of last resort. Suppliers lend to firms no one else lends to because they may have a comparative advantage in getting information about buyers cheaply, they have a better ability to liquidate goods, and they have a greater implicit equity stake in the firm's long term survival. We find some evidence consistent with the use of trade credit as a means of price discrimination. Finally, we find that firms with better access to credit from financial institutions offer more trade credit. This suggests that firms may intermediate between institutional creditors and other firms who have limited access to financial institutions.
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Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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22 Aug 98
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Last Revised:
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22 Aug 98
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0
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Abstract:
In addition to borrowing from financial institutions, firms may be financed by their suppliers. Although there are many theories explaining why non financial firms lend money, there are few comprehensive empirical tests of these theories. This paper attempts to fill the gap. We focus on a sample of small firms whose access to capital markets may be limited. We find evidence that firms use trade credit relatively more when credit from financial institutions is not available. Thus while short term trade credit may be routinely used to minimize transactions costs, medium term borrowing against trade credit is a form of financing of last resort. Suppliers lend to firms no one else lends to because they may have a comparative advantage in getting information about buyers cheaply, they may have a better ability to liquidate goods, and they may have a greater implicit equity stake in the firm's long term survival. We find some evidence that trade credit is used as a means of price discrimination. Finally, we find that firms with better access to credit from financial institutions offer more trade credit. This supports the view that trade credit may be a channel through which monetary policy affects firms outside the banking system.
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36.
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Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business
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23 Aug 00
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Last Revised:
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23 Aug 00
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94 (89,343)
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327
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Abstract:
This paper provides a simple model showing that the extent of competition in credit markets is important in determining the value of lending relationships. Creditors are more likely to finance credit constrained firms when credit markets are concentrated because it is easier for these creditors to internalize the benefits of assisting the firms. The model has implications about the availability and the price of credit as firms age in different markets. The paper offers evidence for these implications from small business data. It concludes with conjectures on the costs and benefits of liberalizing financial markets, as well as the timing of such reforms.
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37.
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Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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25 Jan 06
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Last Revised:
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25 Jan 06
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89 (92,754)
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63
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Abstract:
Developments in the financial sector have led to an expansion in its ability to spread risks. The increase in the risk bearing capacity of economies, as well as in actual risk taking, has led to a range of financial transactions that hitherto were not possible, and has created much greater access to finance for firms and households. On net, this has made the world much better off. Concurrently, however, we have also seen the emergence of a whole range of intermediaries, whose size and appetite for risk may expand over the cycle. Not only can these intermediaries accentuate real fluctuations, they can also leave themselves exposed to certain small probability risks that their own collective behavior makes more likely. As a result, under some conditions, economies may be more exposed to financial-sector-induced turmoil than in the past. The paper discusses the implications for monetary policy and prudential supervision. In particular, it suggests market-friendly policies that would reduce the incentive of intermediary managers to take excessive risk.
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38.
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Eswar S. Prasad Cornell University Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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Last Revised:
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14 Jan 06
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88 (0)
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12
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Abstract:
In this paper, we develop a proposal for a controlled approach to capital account liberalization for economies experiencing large capital inflows. The proposal essentially involves securitizing a portion of capital inflows through closed-end mutual funds that issue shares in domestic currency, use the proceeds to purchase foreign exchange from the central bank and then invest the proceeds abroad. This would eliminate the fiscal costs of sterilizing those inflows, give domestic investors opportunities for international portfolio diversification and stimulate the development of domestic financial markets. More importantly, it would allow central banks to control both the timing and quantity of capital outflows. This proposal could be part of a broader toolkit of measures to liberalize the capital account cautiously when external circumstances are favorable. It is not a substitute for other necessary policies such as strengthening of the domestic financial sector or, in some cases, greater exchange rate flexibility. But it could in fact help create a supportive environment for these essential reforms.
Capital inflows, foreign exchange reserves, closed-end mutual fund, international portfolio diversification
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39.
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Krishna B. Kumar University of Southern California Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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10 Jun 00
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Last Revised:
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04 Oct 01
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68 (109,765)
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72
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Abstract:
Motivated by theories of the firm, which we classify as technological' or organizational,' we analyze the determinants of firm size across industries and across countries in a sample of 15 European countries. We find that, on average, firms facing larger markets are larger. At the industry level, we find firms in the utility sector are large, perhaps because they enjoy a natural, or officially sanctioned, monopoly. Capital intensive industries, high wage industries, and industries that do a lot of R&D have larger firms, as do industries that require little external financing. At the country level, the most salient findings are that countries with efficient judicial systems have larger firms, and, correcting for institutional development, there is little evidence that richer countries have larger firms. Interestingly, institutional development, such as greater judicial efficiency, seems to be correlated with lower dispersion in firm size within an industry. The effects of interactions (between an industry's characteristics and a country's environment) on size are perhaps the most novel results in the paper, and are best able to discriminate between theories. As the judicial system improves, the difference in size between firms in capital intensive industries and firms in industries that use little physical capital diminishes, a finding consistent with size of firms in industries dependent on external finance is larger in countries with better financial markets, suggesting that financial constraints limit average firm size.
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40.
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A Pragmatic Approach to Capital Account Liberalization
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Show Abstracts |
Hide Abstracts |
Versions (2)
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hide multiple versions |
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Eswar S. Prasad Cornell University Raghuram G. Rajan University of Chicago - Booth School of Business
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Posted:
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23 May 08
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Last Revised:
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10 Jun 08
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61 (116,340) |
17
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Eswar S. Prasad Cornell University Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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09 Jun 08
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10 Jun 08
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17
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17
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Abstract:
Cross-country regressions suggest little connection from foreign capital inflows to more rapid economic growth for developing countries and emerging markets. This suggests that the lack of domestic savings is not the primary constraint on growth in these economies, as implicitly assumed in the benchmark neoclassical framework. We explore emerging new theories on both the costs and benefits of capital account liberalization, and suggest how one might adopt a pragmatic approach to the process.
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Eswar S. Prasad Cornell University Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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23 May 08
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Last Revised:
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23 May 08
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44
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17
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Abstract:
Cross-country regressions suggest little connection from foreign capital inflows to more rapid economic growth for developing countries and emerging markets. This suggests that the lack of domestic savings is not the primary constraint on growth in these economies, as implicitly assumed in the benchmark neoclassical framework. We explore emerging new theories on both the costs and benefits of capital account liberalization, and suggest how one might adopt a pragmatic approach to the process.
capital account liberalization, capital controls, collateral benefits, thresholds
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41.
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Viral V. Acharya New York University - Leonard N. Stern School of Business Stewart C. Myers Massachusetts Institute of Technology (MIT) Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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20 Dec 09
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Last Revised:
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23 Dec 09
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59 (118,330)
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5
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Abstract:
We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. Internal governance can mitigate agency problems and ensure that firms have substantial value, even with little or no external governance by investors. Internal governance works best when both top management and subordinates are important in generating cash flow. External governance, even if crude and uninformed, can complement internal governance and improve efficiency. This leads to a theory of investment and dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Our paper can explain why firms with limited external oversight, and firms in countries with poor external governance, can have substantial value.
governance, internal
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42.
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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29 Apr 09
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Last Revised:
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05 Dec 09
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59 (118,330)
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18
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Abstract:
Is there any need to “clean� up a banking system in the midst of a crisis, by closing or recapitalizing weak banks and taking bad assets off bank balance sheets, or can one wait till the crisis is over? We argue that an “overhang� of impaired banks that may be forced to sell assets soon can reduce the current price of illiquid assets sufficiently that weak banks have no interest in selling them. Anticipating a potential future fire sale, cash rich buyers have high expected returns to holding cash, which also reduces their incentive to lock up money in term loans. The potential for a worse fire sale than necessary, as well as the associated decline in credit origination, could make the crisis worse, which is one reason it may make sense to clean up the system even in the midst of the crisis. We discuss alternative ways of cleaning up the system, and the associated costs and benefits.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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43.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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20 Dec 06
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Last Revised:
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20 Dec 06
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59 (118,330)
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15
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Abstract:
Why is underdevelopment so persistent? One explanation is that poor countries do not have institutions that can support growth. Because institutions (both good and bad) are persistent, underdevelopment is persistent. An alternative view is that underdevelopment comes from poor education. Neither explanation is fully satisfactory, the first because it does not explain why poor economic institutions persist even in fairly democratic but poor societies, and the second because it does not explain why poor education is so persistent. This paper tries to reconcile these two views by arguing that the underlying cause of underdevelopment is the initial distribution of factor endowments. Under certain circumstances, this leads to self-interested constituencies that, in equilibrium, perpetuate the status quo. In other words, poor education policy might well be the proximate cause of underdevelopment, but the deeper (and more long lasting cause) are the initial conditions (like the initial distribution of education) that determine political constituencies, their power, and their incentives. Though the initial conditions may well be a legacy of the colonial past, and may well create a perverse political equilibrium of stagnation, persistence does not require the presence of coercive political institutions. We present some suggestive empirical evidence. On the one hand, such an analysis offers hope that the destiny of societies is not preordained by the institutions they inherited through historical accident. On the other hand, it suggests we need to understand better how to alter factor endowments when societies may not have the internal will to do so.
Human capital, institutions
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44.
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Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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27 Oct 04
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Last Revised:
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02 Nov 04
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53 (124,453)
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9
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Abstract:
Emerging markets do not handle adverse shocks well. In this paper, I will outline an explanation of why emerging markets are so fragile, and why they may adopt contractual mechanisms - such as a dollarized banking system - that increase their fragility. I draw on this analysis to explain why dollarized economies may be prone to dollar shortages and twin crises. The model of crises described here differs in some important aspects from what is now termed the first, second, and third generation models of crises. I then examine how domestic policies, especially monetary policy, can mitigate the adverse effects of these crises. Finally, I will ask if there is a constructive role for international financial institutions both in helping to prevent the crises and in helping resolve them.
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45.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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02 Feb 03
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Last Revised:
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09 Oct 09
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53 (124,453)
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2
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Abstract:
How did citizens acquire rights protecting their property from the depredations of the government? In this paper, we argue that one important factor strengthening respect for property is how it is distributed. When there is some specificity associated with property, and property is held by those who are most productive, the distribution of property becomes relatively easy to defend. By contrast, when property is owned by those who get rents simply by virtue of ownership, the distribution of property becomes much harder to defend. We speculate on why some countries have been able to develop a climate of respect for property rights while others have not.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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46.
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Stewart C. Myers Massachusetts Institute of Technology (MIT) Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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13 Jun 00
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Last Revised:
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18 Mar 08
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46 (132,331)
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104
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Abstract:
The more liquid a company's assets, the greater their value in a short-notice liquidation. Liquid assets are generally viewed as increasing debt capacity, other things being equal. This paper focusses on the dark side of liquidity: greater liquidity reduces the ability of borrowers to commit to a specific course of action. It examines the effects of differences in asset liquidity on debt capacity. It suggests an alternative theory of financial intermediation and disintermediation.
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47.
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Raghuram G. Rajan University of Chicago - Booth School of Business Julie M. Wulf Harvard Business School
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| Posted: |
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28 May 04
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Last Revised:
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28 May 04
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45 (133,554)
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30
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Abstract:
Why do some firms tend to offer executives a variety of perks while others offer none at all? A widespread view in the corporate finance literature is that executive perks are a form of agency or private benefit and a way for managers to misappropriate some of the surplus the firm generates. According to this view, firms with plenty of free cash flow that operate in industries with limited investment prospects should typically offer perks. The theory also suggests that firms that are subject to more external monitoring should have fewer perks. Overall, the evidence for the private benefits explanation is, at best, mixed. We do, however, find evidence that perks are offered most in situations where they are likely to enhance managerial productivity. This suggests that a view of perks that sees them purely as managerial excess is incorrect.
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48.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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17 Jul 00
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Last Revised:
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17 Jul 00
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22 (172,469)
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172
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Abstract:
Transactions take place in the firm rather than in the market because the firm offers agents" who make specific investments power. Past literature emphasizes the allocation of ownership as the" primary mechanism by which the firm does this. Within the contractibility assumptions of this" literature, we identify a potentially superior mechanism, the regulation of access to critical resources. " Access can be better than ownership because: i) the power agents get from access is more contingent" on them making the right investment; ii) ownership has adverse effects on the incentive to specialize. " The theory explains the importance of internal organization and third party ownership. "
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49.
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Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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11 Aug 06
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Last Revised:
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22 Sep 06
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21 (175,387)
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10
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| |
Abstract:
Developments in the financial sector have led to an expansion in its ability to spread risks. The increase in the risk bearing capacity of economies, as well as in actual risk taking, has led to a range of financial transactions that hitherto were not possible, and has created much greater access to finance for firms and households. On net, this has made the world much better off. Concurrently, however, we have also seen the emergence of a whole range of intermediaries, whose size and appetite for risk may expand over the cycle. Not only can these intermediaries accentuate real fluctuations, they can also leave themselves exposed to certain small probability risks that their own collective behaviour makes more likely. As a result, under some conditions, economies may be more exposed to financial-sector-induced turmoil than in the past. The paper discusses the implications for monetary policy and prudential supervision. In particular, it suggests market-friendly policies that would reduce the incentive of intermediary managers to take excessive risk.
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50.
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Giovanni Dell'Ariccia International Monetary Fund (IMF) - Research Department Enrica Detragiache International Monetary Fund (IMF) - Research Department Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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12 Oct 05
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Last Revised:
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17 Oct 05
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21 (175,387)
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2
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Abstract:
Banking crises are usually followed by a decline in credit and growth. Is this because crises tend to take place during economic downturns, or do banking sector problems have independent negative effects on the economy? To answer this question we examine industrial sectors with differing needs for financing. If banking crises have an exogenous detrimental effect on real activity, then sectors more dependent on external finance should perform relatively worse during banking crises. The evidence in this paper supports this view. Additional support comes from the fact that sectors that predominantly have small firms, and thus are typically bank dependent, also perform relatively worse during banking crises. The differential effects across sectors are stronger in developing countries, in countries with less access to foreign finance, and where banking crises were more severe.
Banking crises, bank lending channel
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51.
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Kalpana Kochhar International Monetary Fund (IMF) Utsav Kumar International Monetary Fund (IMF) Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF) Ioannis Tokatlidis International Monetary Fund (IMF)
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| Posted: |
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27 Apr 06
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Last Revised:
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03 Jul 09
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20 (178,282)
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10
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Abstract:
India seems to have followed an idiosyncratic pattern of development, certainly compared to other fast-growing Asian economies. While the emphasis on services rather than manufacturing has been widely noted, within manufacturing India has emphasized skill-intensive rather than labor-intensive manufacturing, and industries with typically higher average scale. We show that some of these distinctive patterns existed even prior to the beginning of economic reforms in the 1980s, and argue they stem from the idiosyncratic policies adopted soon after India's independence. We then look to the future, using the growth of fast-moving Indian states as a guide. Despite recent reforms that have removed some of the policy impediments that might have sent India down its distinctive path, it appears unlikely that India will revert to the pattern followed by other countries.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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52.
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Douglas W. Diamond University of Chicago Graduate School of Business Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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04 Aug 09
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Last Revised:
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18 Aug 09
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15 (193,172)
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7
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Abstract:
The cheapest way for banks to finance long term illiquid projects is typically to borrow short term from households. But when household needs for funds are high, interest rates will rise sharply, debtors will have to shut down illiquid projects, and in extremis, will face more damaging runs. Authorities may want to push down interest rates to maintain economic activity in the face of such illiquidity, but intervention may not always be feasible, and when feasible, could encourage banks to increase leverage or fund even more illiquid projects up front. This could make all parties worse off. Authorities may want to commit to a specific policy of interest rate intervention to restore appropriate incentives. For instance, to offset incentives for banks to make more illiquid loans, authorities may have to commit to raising rates when low, to counter the distortions created by lowering them when high. We draw implications for interest rate policy to combat illiquidity.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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53.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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11 Jun 00
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Last Revised:
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11 Jun 00
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15 (193,172)
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18
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Abstract:
Life is replete with instances where two closely related parties forego mutually advantageous opportunities: peace treaties are not signed, inefficient regulations are not altered, and possibilities for investment are frittered away. Since the parties are in close contact, asymmetric information cannot be an explanation for the failure to agree. The explanation this paper offers is based on the assumption that when two parties interact repeatedly, not all aspects of the relationship are contractible. Each party's property rights in the relationship then become endogenous. Efficiency and distribution are not separable in such a world, leading the parties to forego perfectly contractible opportunities. The inability to cooperate is especially severe when one of the parties has relatively poor production opportunities which may explain why the inefficient have undue sway. We explore a number of applications.
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54.
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Eswar S. Prasad Cornell University Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF)
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| Posted: |
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29 Nov 07
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Last Revised:
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29 Nov 07
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14 (196,187)
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62
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Abstract:
We document the recent phenomenon of "uphill" flows of capital from nonindustrial to industrial countries and analyze whether this pattern of capital flows has hurt growth in nonindustrial economies that export capital. Surprisingly, we find that there is a positive correlation between current account balances and growth among nonindustrial countries, implying that a reduced reliance on foreign capital is associated with higher growth. This result is weaker when we use panel data rather than cross-sectional averages over long periods of time, but in no case do we find any evidence that an increase in foreign capital inflows directly boosts growth. What explains these results, which are contrary to the predictions of conventional theoretical models? We provide some evidence that even successful developing countries have limited absorptive capacity for foreign resources, either because their financial markets are underdeveloped, or because their economies are prone to overvaluation caused by rapid capital inflows.
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55.
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Raghuram G. Rajan University of Chicago - Booth School of Business Rodney Ramcharan International Monetary Fund (IMF) - Research Department
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| Posted: |
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20 Jun 09
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Last Revised:
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13 Jul 09
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3 (224,694)
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Abstract:
Economists have argued that a high concentration of land holdings in a country can create powerful interest groups that retard the creation of economic institutions, and thus hold back economic development. Could these arguments apply beyond underdeveloped countries with backward political institutions? We find that in the early 20th century, the distribution of land in the United States is correlated with the extent of banking development. Correcting for state effects, counties with very concentrated land holdings tend to have disproportionately fewer banks per capita in the 1920s. Banks were especially scarce both when landed elites' incentive to suppress finance, as well as their ability to exercise local influence, was higher, suggesting support for a political economy explanation. Counties with high land concentration and fewer banks also had higher interest rates and lower loan to value ratios, consistent with more restricted access to finance. Interestingly, counties with greater land concentration had fewer loan losses during the Great Depression, consistent with borrowers in those counties being less risky, even while they had more limited access to credit in the years leading up to the Depression. We draw lessons from this episode for understanding financial and economic development.
Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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56.
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Franklin Allen University of Pennsylvania - Finance Department Sudipto Bhattacharya London School of Economics Raghuram G. Rajan University of Chicago - Booth School of Business Antoinette Schoar Massachusetts Institute of Technology (MIT) - Sloan School of Management
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| Posted: |
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18 Dec 08
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Last Revised:
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19 Feb 09
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3 (224,694)
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2
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Abstract:
These contributions are seen as falling into three main categories: In a 40-plus year career notable for path-breaking work on capital structure and innovations in capital budgeting and valuation, MIT finance professor Stewart Myers has had a remarkable influence on both the theory and practice of corporate finance. In this article, two of his former students, a colleague, and a co-author offer a brief survey of Professor Myers's accomplishments, along with an assessment of their relevance for the current financial environment.
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57.
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Raghuram G. Rajan University of Chicago - Booth School of Business Arvind Subramanian International Monetary Fund (IMF)
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| Posted: |
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26 Jan 10
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Last Revised:
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26 Jan 10
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0 (0)
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Abstract:
We examine the effects of aid on the growth of manufacturing, using a methodology that exploits the variation within countries and across manufacturing sectors, and corrects for possible reverse causality. We find that aid inflows have systematic adverse effects on a country’s competitiveness, as reflected in the lower relative growth rate of exportable industries. We provide some evidence suggesting that the channel for these effects is the real exchange rate appreciation caused by aid inflows. We conjecture that this may explain, in part, why it is hard to find robust evidence that foreign aid helps countries grow.
Manufacturing, Economic Development, Dutch Disease, CGD, Center for Global Development
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58.
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Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business
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| Posted: |
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17 Nov 09
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Last Revised:
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17 Nov 09
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0 (0)
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Abstract:
Previous studies on the benefits of firm-creditor relationships have focused on whether close ties between firms and their banks help ensure credit for firms, even during difficult financial times. This study considers the strength of firm-creditor relationships and their effects on both the availability and price of credit. Data were used from the National Survey of Small Business Finance collected in 1988 and 1989 by the U.S. Small Business Administration and the Federal Reserve System on 3,404 firms with fewer that 500 employees. Firm borrowing patterns, including number of lenders utilized, size of loans, and loan rates, were examined. Other lender relationship factors were identified, including use of nonloan services with the lending institutions (such as checking and savings accounts), and length of the relationship. Findings show that close relationships between firms and institutional lenders increase the availability and, to a lesser extent, reduce the price of credit to firms. The importance of relationships with lenders is further demonstrated in that borrowing from multiple lenders increases costs and reduces the availability of financing. (SFL)
Debt financing, Access to capital, Institutional alliances, Lending policies, Debt capital, Credit, Banking industry
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59.
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Allen N. Berger University of South Carolina - Moore School of Business Nathan H. Miller affiliation not provided to SSRN Mitchell A. Petersen Northwestern University - Kellogg School of Management Raghuram G. Rajan University of Chicago - Booth School of Business Jeremy C. Stein affiliation not provided to SSRN
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| Posted: |
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17 Nov 09
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Last Revised:
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01 Dec 09
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0 (0)
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Abstract:
Unlike previous research that focused on how technology influences asset ownership, the focus here is on how the environment of a firm impacts its business procedures and business activities.Also explored are several models that hypothesize about the lending habits of small and large banks. Although many of these models are based on theoretical support, this research seeks to find empirical support for them.Previous literature is reviewed, with this research serving as the basis for the hypotheses concerning bank size, and the willingness to accept hard or soft information. To test these hypotheses, data were collected from the Federal Reserve’s 1993 National Survey of Small Business Finance.Bank and market characteristics and firm and contract characteristics were analyzed.The findings indicate that large banks tend to lend to larger firms with good accounting records.Compared to small banks, large banks also have a tendency to lend across a larger distance, to interact more impersonally with borrowers, to have shorter, less restricted relationships, and to ineffectively deal with credit limitations.Small banks make riskier loans based on soft information.Policy issues are discussed, as are areas for further research. (AKP)
FDIC Summary of Deposits, FDIC Consolidated Reports of Condition & Income, Survey of Small Business Finances (Federal Reserve Board), Banking industry, Bank loans, Banks, Credit, Startups, Credit discrimination, Information assessment, Lending policies, Public policies
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60.
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Raghuram G. Rajan University of Chicago - Booth School of Business Enrica Detragiache International Monetary Fund (IMF) - Research Department Giovanni Dell'Ariccia International Monetary Fund (IMF) - Research Department
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06 May 05
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07 Jan 06
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Banking crises are usually followed by a decline in credit and growth. Is this because crises tend to take place during economic downturns, or do banking sector problems have independent negative effects on the economy? To answer this question we examine industrial sectors with differing needs for financing. If banking crises have an exogenous detrimental effect on real activity, then sectors more dependent on external finance should perform relatively worse during banking crises. The evidence in this paper supports this view. Additional support comes from the fact that sectors that predominantly have small firms, and thus are typically bank-dependent, also perform relatively worse during banking crises. The differential effects across sectors are stronger in developing countries, in countries with less access to foreign finance, and where banking crises have been more severe.
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61.
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Anil K. Kashyap University of Chicago - Booth School of Business - Economics Raghuram G. Rajan University of Chicago - Booth School of Business Jeremy C. Stein Harvard University - Department of Economics
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15 Nov 03
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15 Nov 03
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What ties together the traditional commercial banking activities of deposit-taking and lending? We argue that since banks often lend via commitments, their lending and deposit-taking may be two manifestations of one primitive function: the provision of liquidity on demand. There will be synergies between the two activities to the extent that both require banks to hold large balances of liquid assets: If deposit withdrawals and commitment takedowns are imperfectly correlated, the two activities can share the costs of the liquid-asset stockpile. We develop this idea with a simple model, and use a variety of data to test the model empirically.
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62.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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07 Oct 03
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22 Apr 08
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How does the development of the financial sector affect industrial growth? What effect does it have on the composition of industry, and the size distribution of firms? What is the relative importance of financial institutions and financial markets, and does it depend on the stage of economic growth? How do financial systems differ in their vulnerability to crisis? This paper attempts to provide an answer to these questions based on the current state of empirical research.
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63.
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Stewart C. Meyers Massachusetts Institute of Technology (MIT) Raghuram G. Rajan University of Chicago - Booth School of Business
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29 Aug 98
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29 Aug 98
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The more liquid a company's assets, the greater their value in a short-notice liquidation. Liquid assets are generally viewed as increasing debt capacity, other things being equal. This paper focuses on the dark side of liquidity: greater liquidity reduces the ability of borrowers to commit to a specific course of action. It examines the effects of differences in asset liquidity on debt capacity. It suggests an alternative theory of financial intermediation and disintermediation.
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64.
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Randall S. Kroszner U.S. Council of Economic Advisors Raghuram G. Rajan University of Chicago - Booth School of Business
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25 Apr 98
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01 Sep 98
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This paper investigates empirically whether the internal organization of the firm can play an important role in affecting a firm's ability to commit to a particular quality of business practices and, if so, whether competition would be sufficient to lead firms to adopt that structure. In particular, we study how commercial banks have developed "firewalls" to address potential conflicts of interest when they are also engaged in investment banking. Before the 1933 Glass-Steagall Act forced banks out of investment banking, commercial banks organized their securities activities in two ways: as an internal securities department within the bank and as a separately incorporated affiliate with its own board of directors. Although the internal departments underwrote seemingly higher quality firms and securities than did comparable affiliates, the departments obtained lower prices for the issues they underwrote. The greater risk premium associated with the internal department is consistent with investors discounting for the greater likelihood of conflicts of interest when lending and underwriting are within the same structure. Commercial banks responded to this pricing disadvantage for the internal departments by moving strongly toward adopting the separate affiliate structure during the period. We find that increasing the proportion of affiliate directors who are independent from the parent bank reduced the risk premium for the securities underwritten by the affiliate. Independent directors thus appear to have provided an important mechanism by which the affiliates could enhance their credibility in the market. Overall, our results suggest that organizational design can be an effective commitment device and, absent other distortions, competitive pressures would provide sufficient incentives for banks to adopt an organizational design that would address regulatory concerns about potential conflicts of interest.
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65.
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Raghuram G. Rajan University of Chicago - Booth School of Business
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06 Apr 98
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11 Apr 98
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Commercial banks emerged at a time when contracts were very incomplete and property rights insecure. They typically offered demand deposits, made loans on demand, and were regulated. Each of these aspects of the institutional structure were essential in helping the bank provide the twin functions of liquidity and safety. I argue that recent theories of banking, which I collectively refer to as "Incomplete Contract" theories of banking, explain well the origins of banking. I also claim that they can explain recent changes in banking; as the informational, legal, and property rights environment has improved, there appear to be fewer synergies between various aspects of the traditional institutional structure of the bank. In developed countries, it is now time to think whether there is anything special about the institutional form of the bank, or whether all that is special is that it is regulated.
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66.
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Raghuram G. Rajan University of Chicago - Booth School of Business Henri Servaes London Business School
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31 Mar 97
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31 Dec 97
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We examine data on analyst following for a sample of initial public offerings (IPOs) completed over the 1975-1987 period to see how they relate to three well-documented IPO anomalies. We find that higher underpricing leads to increased analyst following. Analysts are overoptimistic about the earnings potential of recent IPOs and about their long term growth prospects. More firms complete IPOs when analysts are particularly optimistic about the growth prospects of recent IPOs. In the long run, IPOs have better stock price performance when analysts ascribe low growth potential to these firms than when they ascribe high growth potential. These results suggest that the anomalies documented in the IPO market may, at least partially, be driven by overoptimism.
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67.
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Covenants and Collateral as Incentives to Monitor
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Raghuram G. Rajan University of Chicago - Booth School of Business Andrew Winton University of Minnesota - Twin Cities - Carlson School of Management
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19 Sep 94
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05 Feb 98
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Raghuram G. Rajan University of Chicago - Booth School of Business Andrew Winton University of Minnesota - Twin Cities - Carlson School of Management
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13 Oct 95
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05 Feb 98
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Although monitoring borrowers is thought to be a major function of financial institutions, the presence of other claimants reduces an institutional lender's incentive to engage in costly monitoring. Thus loan contracts must be structured so as to enhance this incentive. Short-term debt gives the lender the power to force renegotiation or liquidation when the debt matures, but this ability is not contingent on monitoring. By contrast, covenants make the loan's effective maturity, and the ability to collateralize makes the loan's effective priority, contingent on monitoring by the lender. Thus both covenants and collateral can be motivated as contractual devices that increase a lender's incentive to monitor. These results are consistent with a number of stylized facts about the use of covenants and collateral in institutional lending.
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Raghuram G. Rajan University of Chicago - Booth School of Business Andrew Winton University of Minnesota - Twin Cities - Carlson School of Management
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19 Sep 94
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05 Feb 98
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Abstract:
Although monitoring borrowers is thought to be a major function of financial institutions, the presence of other claimants reduces an institutional lender's incentives to do so. Thus loan contracts must be structured to enhance the lender's incentives to monitor. Covenants make the effective maturity of a loan contingent on monitoring by the lender. The ability to secure a loan makes the effective priority of the loan contingent on monitoring by the lender. Thus both covenants and collateral can be motivated as contractual devices that increase a lender's incentive to monitor. These results are consistent with a number of stylized facts about the use of covenants and collateral in bank lending.
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68.
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Raghuram G. Rajan University of Chicago - Booth School of Business Luigi Zingales University of Chicago Booth School of Business
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| Posted: |
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05 Sep 94
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22 Apr 08
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Abstract:
We investigate the determinants of capital structure choice by analyzing the financing decisions of public firms in the major industrialized countries. At an aggregate level, firm leverage is fairly similar across the G-7 countries. We find that the factors identified by previous studies as important in determining the cross-section of capital structure in the US, affect firm leverage in other countries as well. However, a deeper examination of the US and foreign evidence suggests that the theoretical underpinnings of the observed correlations are still largely unresolved.
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