The Effect of External Finance on the Equilibrium Allocation of Capital

Posted: 1 Sep 2004  

Heitor Almeida

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Daniel Wolfenzon

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Abstract

We develop an equilibrium model to understand how the efficiency of capital allocation depends on outside investor protection and the external financing needs of firms. We show that when capital allocation is constrained by poor investor protection, an increase in firms' external financing needs may improve allocative efficiency by fostering the reallocation of capital from low to high productivity projects. We also find novel empirical support for this prediction.

Keywords: capital reallocation, financial development, investor protection, external finance

JEL Classification: G15, G31, D92

Suggested Citation

Almeida, Heitor and Wolfenzon, Daniel, The Effect of External Finance on the Equilibrium Allocation of Capital. Journal of Financial Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=583341

Heitor Almeida (Contact Author)

University of Illinois at Urbana-Champaign ( email )

515 East Gregory Drive
4037 BIF
Champaign, IL 61820
United States
217-3332704 (Phone)

HOME PAGE: http://www.business.illinois.edu/FacultyProfile/faculty_profile.aspx?ID=11357

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Daniel Wolfenzon

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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