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Story - antoq - 10/18/2010 - 13:46 - 155 comments - 0 attachments
Separation of corporate control from ownership is one of the main features of modern capital markets. Among its many virtues, it allows the participation of small investors in the equity market, increasing the supply of funds, dissipating risks across the economy, and lowering the cost of capital for firms.
Its biggest drawback is the agency conflict between corporate insiders who run the firm and can extract private benefits of control, and outside minority investors who have cash flow rights on the firm, but no control rights (e.g. Berle and Means (1932) and Jensen and Meckling (1976)). This agency conflict is the focus of a voluminous body of research in corporate finance. Recurrent corporate scandals constitute a stern reminder of the existence of these conflicts and of the private benefits exploited by insiders even in the least suspicious markets.
This paper investigates the relationship between the liquidity roles of banks, financial fragility and economic growth. It integrates the analysis of liquidity crises into the analysis of the long run growth effects of financial intermediation.
Modigliani and Miller (1958) show that corporate financing decisions do not affect firm value under certain conditions. Their “irrelevance” proposition is powerful because it highlights the factors that make financing decisions value relevant. One of the key assumptions underlying their irrelevance proposition is that that financing and investment decisions are separable and independent activities. When this assumption holds, various financing decisions such as the firm’s organizational, capital, board, and ownership structures do not affect investment decisions or subsequent cash flows.
The rise of project finance, defined as the creation of a legally-independent project company financed with nonrecourse debt, provides strong prima facia evidence that financing structures do, indeed, matter. Total project-financed investment has grown from less than $10 billion per year in the late 1980s to almost $220 billion in 2001 (Esty, 2002a). Within the United States, firms financed $68 billion of capital expenditures through project companies in 2001, approximately twice the amount raised in initial public offerings (IPOs) or invested by venture capital firms. While considerably smaller than the U.S. leasing, asset-backed security, and corporate debt markets—$240 billion, $354 billion, and $434 billion, respectively, in 2001—project finance is, nevertheless, one of the most important financing vehicles for investments in the natural resources and infrastructure sectors such as power plants, toll roads, mines, pipelines, and telecommunications systems. Despite an estimated 40% decline in the use of project finance during 2002, it is likely to grow in the coming years as cash-strapped governments in both developed and developing countries seek ways to finance desperately needed infrastructure investments with private sector participation and capital.
