Ownership and technical efficiency of microfinance institutions: Empirical evidence from Latin America

By using stochastic frontier analysis, this article examines the technical efficiency of different types of microfinance institutions in Latin America. In particular, it tests whether differences in technical efficiency, both intra- and interfirm, can be explained by differences in ownership. With a focus on non-governmental organizations, cooperatives and credit unions, non-bank financial intermediaries, and banks, the data set contains 1681 observations from a panel of 315 institutions operating in 18 Latin American countries. The results show that non-governmental organizations and cooperatives have much lower interfirm and intrafirm technical efficiencies than non-bank financial intermediaries and banks, which indicates the importance of ownership type for technical efficiency.     

Financial development,government ownership of banks and firm innovation

Using a newly-available World Bank survey of over 28,000 firms from 46 countries, we examine how financial development affects firm innovation around the world. We find that while stock market development significantly enhances firm innovation, banking sector development has mixed effects. We show that the latter result can be explained by different levels of government ownership of banks. Specifically, in countries with lower government ownership of banks, banking sector development significantly enhances firm innovation; while in countries with higher government ownership of banks, banking sector development has no significant or sometimes even significantly negative effects on firm innovation. Such negative effects are significantly stronger for smaller firms. The results are robust to various controls such as firms’ human capital and ownership structure, to estimations using instrumental variable techniques and alternative measures of firm innovation.     

Investment cycles and startup innovation

We find that venture capital-backed startups receiving their initial investment in hot markets are more likely to go bankrupt, but conditional on going public, are valued higher on the day of their initial public offering, have more patents, and have more citations to their patents. Our results suggest that VCs invest in riskier and more innovative startups in hot markets (rather than just worse firms). This is particularly true for the most experienced VCs. Furthermore, our results suggest that increased capital in hot times plays a causal role in shifting investments to more novel startups by lowering the cost of experimentation for early stage investors and allowing them to make riskier, more novel, investments.     

Credit supply and corporate innovation

We present evidence that banking development plays a key role in technological progress. We focus on manufacturing firms' innovative performance, measured by patent-based metrics, and employ exogenous variations in banking development arising from the staggered deregulation of banking activities across US states during the 1980s and 1990s. We find that interstate banking deregulation had significant beneficial effects on the quantity and quality of innovation activities, especially for firms highly dependent on external capital and located closer to entering banks. Furthermore, we find that these results are strongly driven by a greater ability of deregulated banks to geographically diversify credit risk.     

The dark side of analyst coverage: The case of innovation

We examine the effects of financial analysts on the real economy in the case of innovation. Our baseline results show that firms covered by a larger number of analysts generate fewer patents and patents with lower impact. To establish causality, we use a difference-in-differences approach that relies on the variation generated by multiple exogenous shocks to analyst coverage, as well as an instrumental variable approach. Our identification strategies suggest a negative causal effect of analyst coverage on firm innovation. The evidence is consistent with the hypothesis that analysts exert too much pressure on managers to meet short-term goals, impeding firms' investment in long-term innovative projects. We further discuss possible underlying mechanisms through which analysts impede innovation and show that there is a residual effect of analysts on innovation even after controlling for these mechanisms. Our paper offers novel evidence on a previously under-explored adverse consequence of analyst coverage—its hindrance to firm innovation.     

Bankruptcies of small firms and lending relationship

This paper empirically investigates the role played by relatively small banks in the Japanese local credit market. We test the hypothesis that small banks enhance the recovery rate from the financial distress and reduce the bankruptcy ratio of small firms. Empirical evidence suggests that small banks specialize more in relationship loans to small firms. However, this expertise is limited to the loans to unincorporated firms or those with a very small number of employees.     

Financial development and innovation: Cross-country evidence

We examine how financial market development affects technological innovation. Using a large data set that includes 32 developed and emerging countries and a fixed effects identification strategy, we identify economic mechanisms through which the development of equity markets and credit markets affects technological innovation. We show that industries that are more dependent on external finance and that are more high-tech intensive exhibit a disproportionally higher innovation level in countries with better developed equity markets. However, the development of credit markets appears to discourage innovation in industries with these characteristics. Our paper provides new insights into the real effects of financial market development on the economy.     

Business credit information sharing and default risk of private firms

We investigate whether and how business credit information sharing helps to better assess the default risk of private firms. Private firms represent an ideal testing ground because they are smaller, more informationally opaque, riskier, and more dependent on trade credit and bank loans than public firms. Based on a representative panel dataset that comprises private firms from all major industries, we find that business credit information sharing substantially improves the quality of default predictions. The improvement is stronger for older firms and those with limited liability, and depends on the sharing of firms’ payment history and the number of firms covered by the local credit bureau office. The value of soft business credit information is higher the smaller the firms and the lower their distance from the local credit bureau office. Furthermore, in spatial and industry analyses we show that the higher the value of business credit information the lower the realized default rates. Our study highlights the channel through which business credit information sharing adds value and the factors that influence its strength.     

Competition and innovation: Evidence from financial services

This paper presents new evidence on the relationship between competition and innovation by extending previous literature from manufacturing to financial services. We introduce a new measure of overall innovation by estimating and enveloping annual minimum cost frontiers to create a global frontier. The distance to the global frontier constitutes each bank’s technology gap, which decreases if the bank manages to innovate. Our innovation measure enables us to derive and estimate the model of Aghion et al. (2005b) at the firm level for the US banking industry. Based on individual bank Call Report data for the period 1984–2004, consistent with theoretical and empirical work by Aghion et al., we find evidence of an inverted-U relationship between competition and innovation that is robust over several different specifications. Further evidence on major structural changes in the US banking industry indicates that banks moved beyond their optimal innovation level and that interstate banking deregulation resulted in lower bank innovation. Policy implications to financial reform and prudential regulation are discussed also.     

Great expectations: Banks as equity underwriters

We examine the in-roads commercial banks have made into equity underwriting over 1990–2002. While banks end the period handling upwards of 25% of equity underwriting, this increase results almost exclusively from acquisitions of investment banks with an already established market share of equity underwriting. We find a significant decline in the market share of equity underwriting that banks acquired in the post-merger period, a decline that is larger than that experienced by independent investment banks of comparable reputation. Banks lose market share because they originate fewer IPOs and their IPOs have a lower incidence of follow-on SEOs compared to independent investment banks. Following the merger, banks experience a large fall off in their ability to retain follow-on SEOs and are less successful in winning SEO mandates when an issuer switches from its IPO underwriter. Overall, the findings suggest it has been difficult for banks to achieve scope economies in equity underwriting.     

Entrepreneurial finance: Banks versus venture capital

We analyze how entrepreneurial firms choose between two funding institution: banks, which monitor less intensively and face liquidity demands from their own investors, and venture capitalists, who can monitor more intensively but face a higher cost of capital because of the liquidity constraints that they impose on their own investors. Because the firm's manager prefers continuing the firm over liquidating it and aggressive (risky) continuation strategies over conservative (safe) continuation strategies, the institution must monitor the firm and exercise some control over its decisions. Bank finance takes the form of debt, whereas venture capital finance often resembles convertible debt. Venture capital finance is optimal only when the aggressive continuation strategy is not too profitable, ex ante; the uncertainty associated with the risky continuation strategy (strategic uncertainty) is high; and the firm's cash flow distribution is highly risky and positively skewed, with low probability of success, low liquidation value, and high returns if successful. A decrease in venture capitalists’ cost of capital encourages firms to switch from safe strategies and bank finance to riskier strategies and venture capital finance, increasing the average risk of firms in the economy.     

The impact of banking regulations on banks' cost and profit efficiency: Cross-country evidence

This paper uses stochastic frontier analysis to provide international evidence on the impact of the regulatory and supervision framework on bank efficiency. Our dataset consists of 2853 observations from 615 publicly quoted commercial banks operating in 74 countries during the period 2000-2004. We investigate the impact of regulations related to the three pillars of Basel II (i.e. capital adequacy requirements, official supervisory power, and market discipline mechanisms), as well as restrictions on bank activities, on cost and profit efficiency of banks, while controlling for other country-specific characteristics. Our results suggest that banking regulations that enhance market discipline and empower the supervisory power of the authorities increase both cost and profit efficiency of banks. In contrast, stricter capital requirements improve cost efficiency but reduce profit efficiency, while restrictions on bank activities have the opposite effect, reducing cost efficiency but improving profit efficiency.     

Public and private enforcement of securities laws: Resource-based evidence

Ascertaining which enforcement mechanisms work to protect investors has been both a focus of recent work in academic finance and an issue for policy-making at international development agencies. According to recent academic work, private enforcement of investor protection via both disclosure and private liability rules goes hand in hand with financial market development, but public enforcement fails to correlate with financial development and, hence, is unlikely to facilitate it. Our results confirm the disclosure result but reverse the results on both liability standards and public enforcement. We use securities regulators’ resources to proxy for regulatory intensity of the securities regulator. When we do, financial depth regularly, significantly, and robustly correlates with stronger public enforcement. In horse races between these resource-based measures of public enforcement intensity and the most common measures of private enforcement, public enforcement is overall as important as disclosure in explaining financial market outcomes around the world and more important than private liability rules. Hence, policymakers who reject public enforcement as useful for financial market development are ignoring the best currently available evidence.     

Sharing information in the credit market: Contract-level evidence from U.S. firms

We investigate the impact of lenders' information sharing on firms' performance in the credit market using rich contract-level data from a U.S. credit bureau. The staggered entry of lenders into the bureau offers a natural experiment to identify the effect of lenders' improved access to information. Consistent with the predictions of 35 and 36 and Pagano and Jappelli (1993), we find that information sharing reduces contract delinquencies and defaults, especially when firms are informationally opaque. The results also reveal that information sharing does not reduce the use of guarantees, that is, it may not loosen lending standards.     

The bright and dark side of staging: Investment performance and the varying motivations of private equity firms

Previous papers that examined investment decisions by private equity funds are divided on whether staging has a positive or negative effect on returns. We believe these opposing views can be reconciled by studying when staging is used during the life of the investment relationship: We find that staging has a positive effect on investment returns in the beginning of the investment relationship, consistent with the notion that staging helps mitigate information asymmetry. However, staging appears to be negatively associated with returns when used prior to the exit decision. Our unique dataset allows us to measure these intertemporal effects precisely.     

Corruption in bank lending to firms: Cross-country micro evidence on the beneficial role of competition and information sharing

Building on the important study by Beck, Demirguc-Kunt, and Levine [2006. Bank supervision and corruption in lending. Journal of Monetary Economics 53, 2131-2163], we examine the effects of both borrower and lender competition as well as information sharing via credit bureaus/registries on corruption in bank lending. Using the unique World Bank data set (WBES) covering more than 4,000 firms across 56 countries with information on credit bureaus/registries, assembled by Djankov, McLiesh, and Shleifer [2007. Private credit in 129 countries. Journal of Financial Economics 84, 299–329], and bank regulation data collected by Barth, Caprio, and Levine [2006. Rethinking Bank Regulation: Till Angels Govern. Cambridge University Press, New York] to measure bank competition and information sharing, we find strong evidence that both banking competition and information sharing reduce lending corruption, and that information sharing also helps enhance the positive effect of competition in curtailing lending corruption. We also find that the ownership structure of firms and banks, legal environment, and firm competition all exert significant impacts on lending corruption.     

Governance and innovation

I examine the relation between the presence of governance provisions and corporate innovation for a sample of firms between 1984 and 1997. I find a positive relation between four proxies for innovation and the broad Gompers, Ishii, and Metrick (2003) Index. However, in subsample analyses, I find that only those provisions that officers and directors actively adopt are positively related to innovation; coverage by state-level antitakeover legislation is typically unassociated or negatively associated with innovation. The evidence suggests that it is the visibility of officers and directors' actions rather than the potency of the takeover protection that best explains the observed pattern.     

On the Riskiness of Universal Banking: Evidence from Banks in the Investment Banking Business Pre- and Post-GLBA

We explore whether an economically significant differential exists in market-based risk measures between universal banks and traditional banks. Using a three-asset portfolio regression model, we find that between 1990 and 2007—a period of gradual deregulation culminating in passage of the Gramm–Leach–Bliley Act (GLBA) of 1999—an increased participation in investment banking was associated with higher total and unsystematic risks and no significant change in systematic risk. Small risk-reduction benefits emerged in the post-GLBA era, but such benefits were likely the result of the particular sample period rather than a fundamental change in bank structure following the GLBA. Our results cannot justify the GLBA on risk-reduction grounds, though the Act may be defensible for other reasons.     

Efficiency,technical change,and returns to scale in large US banks: Panel data evidence from an output distance function satisfying theoretical regularity

This paper provides parametric estimates of technical change, efficiency change, economies of scale, and total factor productivity growth for large banks (those with assets in excess of $1 billion) in the United States, over the period from 2000 to 2005. This is done by estimating an output distance function subject to theoretical regularity within a Bayesian framework. We find that failure to incorporate theoretical regularity conditions results in mismeasured shadow revenue and/or cost shares, which in turn leads to perverse conclusions regarding productivity growth. Our results from the regularity-constrained model show that total factor productivity of the large US banks grew at an average rate of 1.98% over the sample period. However, our estimates also show a clear downward trend in the growth rate of total factor productivity and our decomposition of the primal Divisia total factor productivity growth index into its three components – technical change, efficiency change, and economies of scale – indicates that technical change is the driving force behind this decline.     

Bank ownership and executive perquisites: New evidence from an emerging market

Direct bank ownership is a common practice in emerging markets. The current paper studies how bank ownership affects firm performance through corporate executive perquisites (perks) in China, a leading emerging economy. In addition to common factors known to influence the level of executive perks, we find a significantly positive link between bank ownership of company shares and executive perquisites. Further analyses suggest that higher level of executive perquisites hurt firm operating efficiency. Specifically, perks are positively associated with interest rate paid by the firms. We find some evidence consistent with the notion that the conflict of interests that banks face as both lenders and shareholders in the emerging markets induces banks to play less effective monitoring if they are concerned with the security of their loans or aim to obtain better arrangement for their loans. Our results reveal a particular mechanism through which bank ownership influences firm decisions and performance.