Long-Term Financing Decisions under Conditions of Transitional Economy

Abstract

The paper deals with problems of attracting long term financial resources to finance capital investments in countries with transitional economies. The latter are generally characterized by high degree of informational asymmetry and low transparency of their financial markets, as well as heavy legacy of planned economy. The main purpose of the paper was to analyze in terms of risk and return the factors, affecting long term financing decisions in inefficient and nontransparent capital markets and to study the applicability of different approaches to long term corporate financing in unstable conditions of transitional economy. Among the problems affecting the growth prospects of Russian economy as a whole the problem of gross mismatch between the funds potentially available and the actual investment needs has been singled out as the major obstacle hampering investment process. This mismatch manifests itself both in terms of term structure and interest rate structure of supply and demand for funds. Another problem is a deep misunderstanding at the official level of the objective nature of risk-return tradeoff in financial decisionmaking. The practical consequences of those problems have been discussed in detail. As a result of the analysis it has been shown that the inherent contradiction between the demand for long term funds and the very structure of commercial banks' liabilities, effectively prohibits banks' large scale investments in fixed assets either in the form of participation in equity capital or by offering long-term loans at fixed rates. When considered from the point of view of a corporation in need of long term external financing, the two components of the overall financial risk were singled out. The first one is the unavoidable interest rate risk caused by the mismatch between required long term fixed rates and offered floating rates. The other component is the replacement risk, caused by using of short term liabilities to finance long term investments. In an unstable economy that could result in severe liquidity problems. As a result firms accept only projects promising very high expected returns and short payback periods. Besides the negative effect on overall economic growth, the time mismatch between assets and liabilities has been concluded to adversely affect calculation of the weighted average cost of capital. The major result of the analysis can be summarized as follows: it is mainly through the mechanism of capital markets that the long term capitals can be attracted to an economy in transition; the funds accumulated in commercial banks are of specific term and interest rate structure and are not very suitable for long term investments. Among the prerequisites of enhancing the role of financial markets in redistribution of financial resources is legalization of free movement of capitals over the national borders. As for the practical strategy of involving individual savings kept in cash into the investment process, the recommended approach for corporations is to issue debt securities, tailored specially to attract individuals: informational asymmetry of Russian stock market is too strong to attract individual savings in substantial volumes.