Capital Flows with Debt- and Equity-Financed Investment: Equilibrium Structure and Efficiency Implications
21 Pages Posted: 15 Feb 2006
Date Written: November 1998
This paper distinguishes between debt and equity flows in the presence of information asymmetry between the firm`s "insiders" and "outsiders" in a small open economy. It shows the inadequacy of capital investment because its scope is too narrow and the investment each firm makes is too little. An unconventional policy tool is proposed to correct the market failure: lump-sum subsidies to firms that choose to equity-finance their investments.
Keywords: debt and equity, efficient capital flows, asymmetric information, corrective policy
JEL Classification: F21, F35, H25, H30
Suggested Citation: Suggested Citation