Financial Markets and the Allocation of Capital

Abstract

Financial markets appear to improve the allocation of capital--across 65 countries, those with developed financial markets increase investment more in growing industries, and decrease investment more in declining industries, than financially undeveloped countries. The efficiency of capital allocation is also negatively correlated with the extent of state ownership in the economy, and positively correlated with the degree of firm-specific movement in domestic stock returns and the legal protection of investors (which appears to be particularly useful for limiting investment in declining industries).

JEL Classification: E22, G20, N20