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March 1995 Programs to direct credit to industry can be uniquely beneficial if 1. the purpose of government credit is to relax borrowing constraints on firms, as an end in itself, or (2) other government objectives can best be achieved by relaxing firms' borrowing constraints (in which case, product and factor market externalities motivate government credit programs). According to Japanese officials, government involvement is warranted when: 1. investment risk is too high for a particular activity (because it is too large-scale or high-tech, or needs long gestation and market development); 2. there is a big discrepancy between private and social benefits when industries or parts of industries may save foreign exchange, for example, and thus relieve the balance of payments constraint on other growth industries); 3. information problems discourage lending to small and medium-scale industries; 4. infant industries face large social set-up costs. The authors examine the effect of policy-based finance for the period 1963-91 for Japan's machine tool industry, an industry with high potential spillover effects on technological innovation and learning. They found that directed credit may have helped to promote investment among postwar Japanese machine tool producers. Important components of that credit seem to have spurred growth. The government credit programs did not crowd out private funds and did not succeed by providing a permanent lifeline (credit insurance) to firms. But the authors do not endorse government interventions in credit markets. For one thing, the effective operation of industrial directed credit in Japan seems to be an unrepresentative case. In many countries, such government intervention has produced large costs: inefficient borrowers have been funded and public funds have been captured by special interests. In Japan, directed-credit policy is designed to promote investment, crowd in private funds, and avoid the capture of policy funds by particular firms or industries. The priorities of credit policy are determined as part of a national plan with broad participation (rather than by special-interest lobbying), and once industry-level priorities have been established, firm-level lending decisions by agencies are shielded from political pressure. In political systems that cannot implement such effective plans for distributing industrial credit, government-directed credit programs may create more problems than they solve.
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Himmelberg, Hubbard, and Love combine the agency theory of the firm with risk diversification incentives for insiders. Principal-agent problems between insiders and outsiders force insiders to retain a larger share in their firm than they would under a perfect risk diversification strategy. The authors predict that this higher share of insider ownership and the resulting exposure of insiders to higher idiosyncratic risk will result in underinvestment and higher cost of capital. Using firm-level data from 38 countries, the authors provide evidence in support of their theoretical model, showing that the premium for bearing idiosyncratic risk varies between zero and six percent and decreases in the level of outside investor protection. The results of the study imply that policies aimed at strengthening investor protection laws and their enforcement will improve capital allocation and result in higher growth. This paper-a product of Finance, Development Research Group-is part of a larger effort in the group to study corporate governance and access to finance. The authors may be contacted at cph15@columbia.edu or ilove@worldbank.org.
Capital Investment --- Capital Stock --- Contract --- Debt Markets --- Economic Theory and Research --- Emerging Markets --- Equity --- Equity Stakes --- Finance --- Finance and Financial Sector Development --- Financial Development --- Financial Literacy --- Holding --- Investment --- Investment and Investment Climate --- Investment Decisions --- Investor --- Investor Protection --- Investor Protections --- Labor Policies --- Legal Environment --- Macroeconomics and Economic Growth --- Market --- Microfinance --- Outside Investors --- Ownership Structure --- Political Economy --- Private Sector Development --- Return --- Risk Aversion --- Shareholders --- Social Protections and Labor
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