Does Equity Market Stifle Private Credit Market?
Mohammad M. Rahaman
Saint Mary's University - Sobey School of Business
April 25, 2012
Why do countries differ so much in terms of their financial systems? Are banks and equity competing or complementary sources of financing for firms? To address these questions, I study various determinants of capital market development and whether these determinants favor one form of capital (equity capital) over the other (private bank credit) during the process of financial development. I find that capital market development is primarily demand driven. The demand for finance affects the equity market development disproportionately more (in a non-linear way) than it does the private bank credit market. Furthermore, the relative strength of enforcement of creditors' and minority shareholders' rights also significantly determines whether external financing is predominantly raised through private arrangement of credit or through the public equity market. Through the power of demand and enforcement, we can explain the prominence of the market-based financial system in recent years. I find that the signs and significance of various political and legal endowments in affecting financial development crucially depend on the conditioning information set of the regression, and thus may not be very informative in understanding the co-development of various segments of the capital market. Despite the prominence of the market-based system in recent years, I show that no financial system is inherently superior to the other, rather differences in the underlying determinants of capital market development shape which form of capital is going to be the dominant one in a financial system.
Number of Pages in PDF File: 39
Keywords: Financial Development, Financial System, Equity-based System, Bank-based System
JEL Classification: G00, G10, G21, O16working papers series
Date posted: April 25, 2012
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