Capital Market Imperfections Research Articles

Capital structure and business failure: The collapse of Canada’s Dome Petroleum

In popular lore, the failure of Canada’s once-biggest company, Dome Petroleum, was caused by the interventionist policies of the federal government or its misadventures drilling for oil in the Arctic. But these factors acted in varied ways on the company. Rather, corporate finance theories offer more insight into the dynamics that led to Dome’s takeover by the American oil major Amoco in 1988. Dome was unique in its unwillingness to issue new share capital during its growth phase and instead relied on easy debt financing. This in turn was a result of both insider preferences as well as capital market imperfections. The transformation of capital structure from a background into a critical weakness, this paper argues, making use of newly available data and company archives, provides a more convincing explanation of Dome’s failure than other factors. The relevance of capital structure highlights the enduring analytic utility of the Modigliani-Miller theorem of capital structure irrelevance.

What else lies behind the credit rationing? Exploring the issue of employment

PurposeThis paper aims to review the literature extensively by analysing recent work and providing a guide for models, data sets and research findings.Design/methodology/approachThis paper reviews the literature extensively by analysing recent work and providing a guide for models, data sets and research findings within the context of capital market imperfections. The authors further break down the literature into closer-in-nature categories for reader’s convenience and comprehension. Finally, the authors address gaps in the existing literature and propose government policies that can tone down the potential effect of credit rationing on employment.FindingsThis paper provides a map of the literature so as to help future researchers in the relevant literature and give a short insight of what has been explored so far.Originality/valueThis paper is original and is the result of a thorough review of an extensive literature.

Customer concentration and stock price crash risk: new evidence from China

ABSTRACT Using the sample of A-share listed companies from 2011 to 2022, we show a robust negative relationship between customer concentration and stock price crash risk in China. This finding contrasts with previous research based on U.S. firms, which shows that customer concentration is positively correlated with stock price crash risk. We believe that the Chinese imperfect capital market is the key factor contributing to this divergence. We reveal that a concentrated customer base can reduce stock price crash risk by improving corporate governance and supply chain transparency. Heterogeneity analysis shows that the effect is more pronounced for firms located in regions with low marketization level and those receiving less market attention.

Discussion on the Advantages and Disadvantages of the DCF Model in the Current Era and the Improvement of the Model

The discounted cash flow model is a company value evaluation method widely used by many domestic investors when investing company. However, under the background of the epidemic, due to factors like low benchmark interest rates that are not conducive to the valuation of the DCF model, the accuracy of the discounted cash flow model valuation has been questioned. In addition, the DCF model is not entirely applicable to the domestic market because of the multiple systems and the local capital market's imperfections, so the model needs to be improved. In this paper, the existing literature is summarized, and it was found that the time series analysis method can be used, which can predict the company's future cash flow more accurately, instead of the sales ratio analysis method, while the discount rate can be calculated more accurately by substituting each company's beta into the calculation instead of using the company's industry beta.

Catching up or getting stuck: convergence in Eastern European economies

The paper studies the convergence and growth behavior of 11 Central and Eastern European members states of the European Union between 2000–2019, using a modified development accounting approach based on the neoclassical growth model. The main goal of the exercise is to decompose the still existing development gap relative to Western Europe (Austria) into three components: convergence, productivity, and long-run factors. The latter may include general institutional features such as population growth, or capital market imperfections measured by the capital wedge. The capital wedge is identified by leveraging the neoclassical growth model’s ability to explain the observed behavior of the capital-output ratio. The main conclusions are that for most countries, lower productivity and capital distortions are both important to understand underdevelopment. Economic policy, therefore, should primarily target productivity growth and a free and efficient capital market.

Analysis of Mechanisms of Production Investment Stimulation in an Imperfect Capital Market Based on a Mathematical Model

The problem of renewed market investment in the Russian real economy is closely related to the business environment state in the imperfect capital market in Russia and to the assessment of the profitability of investment projects. Difficulties in determining profitability in an imperfect monetary and credit system are associated with the significant discrepancy between the interest rates on deposits and loans and can be overcome by applying the Cantor–Lippman approach, which makes it possible to calculate the profitability of a pool of investment projects available to an investor. From the point of view of a production owner, market investment depends on the state of the business environment and competes with investment in consumption. The problem arises of estimating the profitability threshold at which private market investment is preferred to private consumption. We propose an approach to the solution of this problem in terms of a mathematical model of investment behavior of a production owner in an imperfect capital market. The model is formalized as an infinite-horizon optimal control problem with a state constraint. The solution of the problem is based on constructing a viscosity solution of the Hamilton–Jacobi–Bellman equation. It is shown that the investment strategy of a production owner can depend substantially on the business environment state. Based on the results of this study, an explanation is proposed for the transition from recovery growth to stagnation in the Russian economy in late 2007, which was accompanied by recession of investment activities in the manufacturing sector.

Analysis of Mechanisms of Production Investment Stimulation in an Imperfect Capital Market Based on a Mathematical Model

Analysis of Mechanisms of Production Investment Stimulation in an Imperfect Capital Market Based on a Mathematical Model

Transmission Channels of Effects of Inequality in Income Distribution on Economic Growth in the Group of Countries with Lower Levels of Inequality and Economic Development than Average - Suggestions for Vietnam

Using a fixed effects model for processed panel data to increase data homogeneity, the article found that in the group of countries with lower levels of inequality and economic development than average, increased income inequality will stimulate economic growth. This positive effect is the combined result of many different effect transmission channels, of which 6 channels were found including fiscal policy channel, imperfect capital market channel, consumer behavior channel, labor motivation channel, access to education channel and domestic demand for goods and services channel. The article has not found evidence about socio-political instability channel, fertility decision channel, investment savings channel and access to health service channel. From the estimation results, the study has proposed a number of solutions for Vietnam towards harmoniously resolving the relationship between income inequality and economic growth.

Weryfikacja teorii kanału bilansowego podczas pandemii COVID-19: relacja pomiędzy przepływami pieniężnymi a inwestycjami polskich spółek giełdowych

1. Agca S., Mozumdar A. [2008], The impact of capital market imperfections on investment-cash flow sensitivity, Journal of Banking and Finance, 32 (2): 207–216. Google Scholar

Extraction rights allocation with liquidity constraints

We study the optimal allocation of a resource in a second-best world in which parties may be liquidity-constrained due to credit frictions and capital market imperfections. In this setting, common to various natural resource industries, agents are unable to bid more than their budget regardless of their valuation. While auction markets are widely used mechanisms for allocating natural resource extraction rights and conservation contracts, we show that in these circumstances the competitive market –which allocates items based on rank order of bids– fails to achieve the first-best allocation. The market outcome is welfare-dominated by a hybrid mechanism consisting of random assignment followed by resale in a secondary market. Via the initial lottery, the hybrid-mechanism allocates the items with positive probability to high-valuation low-wealth individuals who would not have been able to afford them in a competitive market. High-valuation high-wealth agents, on the other hand, acquire the items in the secondary market if they do not receive them in the initial lottery. Therefore, equity in the allocation of access to the resource may be justified not only by distributional concerns but also by economic efficiency. We illustrate our model using data from buybacks of harvesting rights in the seafood industry.

The importance of institutional and financial resources for export performance associated with technological innovation

This study adopts a resource contingency perspective to examine the impact of technological innovation on export performance of manufacturing firms. In view of institutional voids and capital market imperfections in emerging economies, we propose that two types of resources, institutional resources and financial resources, are of differential value in the innovation-exports nexus. Empirical results, based on a large sample of Chinese manufacturing firms, show that technological innovation embodied in the patent has positive effect on exports, but such effect is diminished by institutional resources (captured by state-ownership, business group affiliation and government subsidy) and enhanced by internal financial resources (captured by financial slack).

Paradigm Shift in Finance: The Transformation of the Theory from Perfect to Imperfect Capital Markets Using the Example of Company Valuation

In the capital market and financing theory, we are currently observing major upheavals. For decades, the neoclassical paradigm has dominated in science and practice. Triggered by economic and political crises, transformations, the COVID-19 pandemic, and political instabilities, a paradigm shift is currently occurring in finance. This paradigm shift leads to models and theories that can explain imperfections in capital markets and provide decision support for managers. The aim of this article is to analyse the paradigm shift and to demonstrate it using an example of business valuation theory. We draw on the insights of the philosopher Thomas Samuel Kuhn. He vividly explains the paradigm shift in science in his major work “The Structure of Scientific Revolutions”. A paradigm shift in science always encounters resistance. The reasons for this include the strong neoclassical school in finance and the dependence on research funds. Funders expect the use of established methods and the simplicity and dissemination of the models that have prevailed so far. On the other hand, the neoclassical models are unsuitable to explain the transformation processes on financial markets. This fact has been empirically proven. We show a variety of arguments that speak clearly about this paradigm shift. Their importance clearly outweighs the reasons to continue subscribing to the old paradigm. Accordingly, new theories and models have been developed to better explain the changes in the markets. With the simulation-based business valuation, an approach has been developed that considers different degrees of market imperfections. The simulation-based valuation can also depict the special case of the neoclassical paradigm, so that all market constellations can be covered.

Opaque liabilities, learning, and the cost of equity capital for insurers

AbstractAnalyzing major US property–liability insurers, we find that their cost of equity capital is negatively associated with their underwriting performance, but not with their investment performance. We provide cross‐sectional evidence that the difference is attributable, at least in part, to investor learning about opaque insurer liabilities. We also find that capital market and product market imperfections are important determinants of insurers' cost of equity capital. Overall, our evidence contributes to the important literature examining insurers' cost of equity capital, and it suggests that opaque liabilities are a distinguishing feature of insurers in determining their cost of equity capital.

No Great Convergence, but not Myth: Stabilization and Growth in East Asia, 1990-2018

Along with global economic integration through trade and financial flows, emerging market economies (EMEs) have become increasingly affected by global fluctuations and structural changes. Also, despite their apparent income convergence since the 2000s, their growth performances have become differentiated across regions. This paper overviews how EMEs in East Asia have coped with these circumstances since the 1990s, and assesses their economic performances from the aspects of both short-run macroeconomic stabilization and long-run economic growth in comparison with other regions. Scrutinizing monetary regime choices in the policy trilemma, dynamic patterns of total capital flows as well as by types of capital, saving-investment gaps and growth finance, and sources of economic growth, the exceptional income convergence of East Asian EMEs imply the following lessons, being apparently heterodox to conventional views: Given volatile global capital flows in the imperfect capital market, in small open economies such as EMEs, 1) for macroeconomic stabilization, exchange rate stability supported by managed float and capital controls is a more reasonable choice than the conventional mix of free float and open capital account, and 2) for economic growth, domestic savings are more reliable and important source of growth finance than foreign capital inflows. In fact, it turns out that 3) capital accumulation has been more important source of long-run economic growth than TFP growth throughout both advanced and emerging market economies. It should be noted, however, that 4) excessive capital accumulation could lead to relatively lower welfare levels than what income levels can attain.

Analysing Global Research on Stock Market Anomalies: A Behavioural Finance Perspective

Investors’ psychology and behaviours have been known to influence the emergence of capital market imperfections. The corpus of studies on this matter is copious but conflicting as researchers approach the subject from two major perspectives. Against this background, this study aims to review and establish the global research trend in behavioural finance examining stock market anomalies vis-à-vis its opposing paradigm (i.e., the efficient market hypothesis). Based on an extensive review of the types of anomalies published by scholars over 53 years (1968 – 2021), this study generated search strings targeting the appropriate investor behaviours as responses to stock market anomalies. The study applied bibliometric analysis and drew 1,767 documents from the Scopus database, which were later reduced to 1,436 after applying the exclusion criteria. The analyses revealed that authors prefer to disseminate their research on stock market anomalies in refereed journals and also attempt to unravel the contrast between rational and behavioural dynamics of investor decision-making based on short-term observations. Also, most of the studies fall under the general economics and business subject groups, indicating authors' preoccupation with general rather than specific matters on stock market anomalies. Further, the study highlighted the global distribution of studies on stock market anomalies, the top prolific authors in the field, the top journal sources, and the Scopus profiles of selected top authors. Based on these results, recommendations for future studies were given.

A Model of Investment Behavior of Enterprise Owner in an Imperfect Capital Market

A Model of Investment Behavior of Enterprise Owner in an Imperfect Capital Market

Financial sustainability: measurement and empirical evidence

Financial sustainability is underrepresented in both the research on and practice of sustainability management and reporting. This article proposes a conceptual measure of financial sustainability and examines its association with capital market returns. The measure is positioned at the intersection of sustainability management, risk management and risk governance. Financial sustainability is regarded as a crucial control parameter complementing shareholder value and can be viewed by risk-averse investors as a secondary condition of investment decisions. It reduces refinancing and insolvency risks, leading to risk-adjusted excess returns in an imperfect capital market with financing restrictions and insolvency costs. We propose measuring a firm’s financial sustainability in terms of four conditions: (1) firm growth, (2) the company’s ability to survive, (3) an acceptable overall level of earnings risk exposure, and (4) an attractive earnings risk profile. We show that the application of a conditions-based investment strategy to European firms with high financial sustainability (i.e., firms fulfilling all four conditions) over the period from July 1990 to June 2019 results in monthly excess returns of 0.39%. This portfolio’s risk is lower than the risk of market investment. We find that the excess returns increase when incrementally adding each of the four conditions to the investment strategy.

Innovation and trade in the presence of credit constraints

AbstractThis paper examines how trade liberalization affects investment in R&D at the firm level. We provide a model with entrepreneurs that differ in their wealth endowments, causing them to rely on external funds to different extents. In the presence of capital market imperfections, this implies heterogeneous access to external financing such that poor entrepreneurs run smaller firms, are less likely to invest in R&D and are more likely to exit the market. Decreasing trade costs resulting from tariff reductions exacerbate these characteristics. Using firm‐level panel data on seven Latin American countries for 2006 and 2010, we find support for our theoretical predictions. While prior research emphasizes a positive impact of trade liberalization on firms’ productivity‐enhancing activities, we provide novel evidence showing that financial constraints can impair the effect on R&D efforts. These results suggest that imperfect capital markets can prevent welfare gains from trade liberalization to materialize.

Capital markets and the costs of climate policies

Globalization is accompanied by increasing current account imbalances. They can undermine the positive impacts of increasing international cooperation and trade on economic growth and income convergence. At the same time, climate change challenges the global community and requests for co-operative action. Regional energy transformation due to climate policies and the resulting regional mitigation costs are key variables of climate economic analysis. This study is the first that include current account imbalances and imperfect capital markets to investigate potential market feedback mechanisms between climate policies, energy sector transformation and capital markets. Furthermore, it answers the question whether the capital-intensive transformation towards zero-carbon economies increases the policy cost of mitigation under the condition of imperfect capital markets. First results demonstrate a dominant baseline effect of capital market imperfections on macroeconomic variables, and moderate effects on mitigation costs in global climate policy scenarios. For some regions (e.g. Middle East) estimates of relatively high mitigation costs are revised downwards, if imperfect capital markets are considered.

Mathematical Modeling of Investments in an Imperfect Capital Market

Mathematical Modeling of Investments in an Imperfect Capital Market