In both corporate finance and asset pricing empirical work, researchers are often confronted with panel data. In these data sets, the residuals may be correlated across firms and across time, and OLS standard errors can be biased. Historically, the two literatures have used different solutions to this problem. Corporate finance has relied on clustered standard errors, while asset pricing has used the Fama-MacBeth procedure to estimate standard errors. This paper examines the different methods used in the literature and explains when the different methods yield the same (and correct) standard errors and when they diverge. The intent is to provide intuition as to why the different approaches sometimes give different answers and give researchers guidance for their use.

/pdf/estimating-standard-errors-in-finance-panel-data-sets-1rry6mh9tl.pdf

Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches

https://scholar.harvard.edu/files/shleifer/files/ip_corpgov.pdf

Investor Protection and Corporate Governance

The author argues that the preponderance of theoretical reasoning and empirical evidence suggests a positive first order relationship between financial development and economic growth. There is evidence that the financial development level is a good predictor of future rates of economic growth, capital accumulation, and technological change. Moreover, cross-country, case-style, industry level and firm-level analysis document extensive periods when financial development crucially affects the speed and pattern of economic development. The author explains what the financial system does and how it affects, and is affected by, economic growth. Theory suggests that financial instruments, markets and institutions arise to mitigate the effects of information and transaction costs. A growing literature shows that differences in how well financial systems reduce information and transaction costs influence savings rates, investment decisions, technological innovation, and long-run growth rates. A less developed theoretical literature shows how changes in economic activity can influence financial systems. The author advocates a functional approach to understanding the role of financial systems in economic growth. This approach focuses on the ties between growth and the quality of the functions provided by the financial systems. The author discourages a narrow focus on one financial instrument, or a particular institution. Instead, the author addresses the more comprehensive question: What is the relationship between financial structure and the functioning of the financial system?

/pdf/financial-development-and-economic-growth-views-and-agenda-1isr9l81uu.pdf

Financial development and economic growth : views and agenda

This paper surveys capital structure theories based on agency costs, asymmetric information, product/input market interactions, and corporate control considerations (but excluding tax-based theories). For each type of model, a brief overview of the papers surveyed and their relation to each other is provided. The central papers are described in some detail, and their results are summarized and followed by a discussion of related extensions. Each section concludes with a summary of the main implications of the models surveyed in the section. Finally, these results are collected and compared to the available evidence. Suggestions for future research are provided.

https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1540-6261.1991.tb03753.x

The Theory of Capital Structure

The event study is an important research tool in economics and finance. The goal of an event study is to measure the effects of an economic event on the value of firms. Event study methods exploit the fact that, given rationality in the marketplace, the effects of an event will be reflected immediately in security prices. Thus the impact can be measured by examining security prices surrounding the event. In this paper event study methods are described including some of the potential complications. An example is included to illustrate the approach.

http://www.business.unr.edu/faculty/liuc/files/BADM742/MacKinlay_1997.pdf

Event Studies in Economics and Finance

We investigate how differences in legal and financial systems affect firms' use of external financing to fund growth. We show that in countries whose legal systems score high on an efficiency index, a greater proportion of firms use long-term external financing. An active, though not necessarily large, stock market and a large banking sector are also associated with externally financed firm growth. The increased reliance on external financing occurs in part because established firms in countries with well-functioning institutions have lower profit rates. Government subsidies to industry do not increase the proportion of firms relying on external financing. THE CORPORATE FINANCE LITERATURE suggests that market imperfections, caused by conflicts of interest and informational asymmetries between corporate insiders and investors, constrain firms in their ability to fund investment projects. The magnitude of these imperfections depends in part on the effectiveness of the legal and financial systems. Because these systems differ across countries, the literature implies that there should exist systematic cross-country differences in firms' ability to obtain external capital to finance investment. In this paper, we examine whether the underdevelopment of legal and financial systems does prevent firms in some countries from investing in potentially profitable growth opportunities. In particular, we focus on the use of long-term debt or external equity to fund growth (see our earlier work, Demirgut-Kunt and Maksimovic (1996a), which compares firms' financial structures in developed and developing countries and finds the greatest difference to be in the provision of long-term credit). We estimate a financial planning model to obtain the maximum growth rate that each firm in our thirty-country sample could attain without access to long-term financing. We then compare these predicted growth rates to growth rates realized by firms in countries with differing degrees of development in their legal and financial systems. Our approach enables us to identify specific characteristics of the legal and financial systems that are associated with long-term financing of firm growth. Thus, we provide a micro-level test of the hypoth

Law, finance, and firm growth

This study uses a new data set to assess whether capital structure theory is portable across countries with different institutional structures. We analyze capital structure choices of firms in 10 developing countries, and provide evidence that these decisions are affected by the same variables as in developed countries. However, there are persistent differences across countries, indicating that specific country factors are at work. Our findings suggest that although some of the insights from modern finance theory are portable across countries, much remains to be done to understand the impact of different institutional features on capital structure choices. OUR KNOWLEDGE OF CAPITAL STRUCTURES has mostly been derived from data from developed economies that have many institutional similarities. The purpose of this paper is to analyze the capital structure choices made by companies from developing countries that have different institutional structures. The prevailing view, for example Mayer ~1990!, seems to be that financial decisions in developing countries are somehow different. Mayer is the most recent researcher to use aggregate f low of funds data to differentiate between financial systems based on the “Anglo-Saxon” capital markets model and those based on a “Continental-German-Japanese” banking model. However, because Mayer’s data comes from aggregate f low of funds data and not from individual firms, there is a problem with this approach. The differences between private, public, and foreign ownership structures have a profound inf luence on such data, but the differences may tell us little about how profit-oriented firms make their individual financial decisions. This paper uses a new firm-level database to examine the financial structures of firms in a sample of 10 developing countries. Thus, this study helps determine whether the stylized facts we have learned from studies of developed countries apply only to these markets, or whether they have more general applicability. Our focus is on answering three questions:

Capital Structures in Developing Countries

Using a unique firm-level survey database covering 54 countries, we investigate the effect of financial, legal, and corruption problems on firms' growth rates. Whether these factors constrain growth depends on firm size. It is consistently the smallest firms that are most constrained. Financial and institutional development weakens the constraining effects of financial, legal, and corruption obstacles and it is again the small firms that benefit the most. There is only a weak relation between firms' perception of the quality of the courts in their country and firm growth. We also provide evidence that the corruption of bank officials constrains firm growth.

https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1540-6261.2005.00727.x

Financial and Legal Constraints to Growth: Does Firm Size Matter?

Financing patterns around the world: Are small firms different?

Do firms in developing countries use less long term debt than similar firms in industrial countries? This paper investigates the role of institutional factors in explaining firms' choice of debt maturity in a sample of 30 countries during 1980-91. Demirguc-Kunt and Maksimovic examine the maturity of firm debt in 30 countries during the period 1980-91. They find systematic differences in the use of long-term debt between industrial and developing countries and between small and large firms. In industrial countries, firms have more long-term debt and a greater proportion of their total debt is held as long-term debt. Large firms have more long-term debt, as a proportion of total assets and debt, than smaller firms do. The authors try to explain the variations in debt composition by differences in the effectiveness of legal systems, the development of stock markets and the banking sector, the level of government subsidies, and firm characteristics. In countries with an effective legal system, both large and small firms have more long-term debt relative to assets and their debt is of longer maturity. Both large and small firms in countries with a tradition of common law use less long-term debt, relative to their assets, than do firms in countries with a tradition of civil law. Large firms in common law countries also use less short-term debt. In countries with active stock markets, large firms have more long-term debt and debt of longer maturity. Neither the level of activity nor the size of the market is correlated with financing choices of small firms. By contrast, in countries with large banking sectors, small firms have less short-term debt and their debt is of longer maturity. Variation in the size of the banking sector does not have a corresponding correlation with the capital structures of large firms. Government subsidies to industry increase long-term debt levels of both small and large firms. For all firms, inflation is associated with less use of long-term debt. The authors also find evidence of maturity-matching for both large and small firms. This paper - a product of the Finance and Private Sector Development Division, Policy Research Department - is part of a larger effort in the department to understand the impact of institutional constraints on firms' financing choices. The study was funded by the Bank's Research Support Budget under the research project Term Finance: Theory and Evidence (RPO 679-62).

Vojislav Maksimovic

Papers

Law, finance, and firm growth

Capital Structures in Developing Countries

Financial and Legal Constraints to Growth: Does Firm Size Matter?

Financing patterns around the world: Are small firms different?

Institutions, Financial Markets and Firm Debt Maturity