Financial Markets and the Allocation of Capital
28 Pages Posted: 14 Dec 2011
Date Written: December 2011
Financial markets appear to improve the allocation of capital. Across 65 countries, those with developed financial sectors increase investment more in their growing industries, and decrease investment more in their declining industries, than those with undeveloped financial sectors. The efficiency of capital allocation is negatively correlated with the extent of state ownership in the economy, positively correlated with the amount of firm-specific information in domestic stock returns, and positively correlated with the legal protection of minority investors. In particular, strong minority investor rights appear to curb overinvestment in declining industries.
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