FINANCIAL MARKETS AND DEVELOPMENT

Author(s): JOSEPH E. STIGLITZ

Source: Oxford Review of Economic Policy , Winter 1989, Vol. 5, No. 4, FINANCE AND
ECONOMIC DEVELOPMENT (Winter 1989), pp. 55-68
Published by: Oxford University Press

Stable URL: https://www.jstor.org/stable/23606232

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide
range of content in a trusted digital archive. We use information technology and tools to increase productivity and
facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at
https://about.jstor.org/terms

Oxford University Press is collaborating with JSTOR to digitize, preserve and extend access to
Oxford Review of Economic Policy

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
OXFORD REVIEW OF ECONOMIC POLICY, VOL. 5, NO. 4

FINANCIAL MARKETS AND

DEVELOPMENT

JOSEPH E. STIGLITZ
Stanford University1

I. INTRODUCTION these countries have, for the most part, not fared
well. But extreme free market solutions have fared
little better, perhaps best illustrated by the experi
Earlier literature cm the development process stressed
the importance of capital accumulation, and encethe
of Chile. True believers in the doctrines of the
leftThis
role of financial institutions in that process. and the right have this in common: they both
claimand
paper stresses the importance of the processes that if the patient had only followed the
doctor's
institutions by which capital is allocated, and theorders more precisely, the medicine would
resulting uses to which it is put have worked.

The shift in the economists' paradigm can be de

My views on this subject have been greatly affected
scribed in several different ways. The earlier litera
both by the experience of developing countries
during the past quarter century and by the ture paid only limited attention to problems of
major
incentives.
shift—evolutionary if not revolutionary—in the Managers managed well because that is
economists' paradigm over that period. Wewhat havethey were supposed to do. The notion that
some
seen that capital accumulation is not enough: individuals might be better managers than
even
others
the extremely high rates of savings of many of the was not even noted; and accordingly, the
socialist economies have not managed to compen problem of how to choose good managers was not
addressed.
sate for their lack of ability in allocating capital, and While the possibility that the interests

1 Financial support from the National Science Foundation, the Olin Foundation, and the Hoover Institution is gratefully ac
knowledged. My work in this area has benefited greatly from helpful conversations over the years with Mark Gersovitz, Jon
athan Eaton, Andrew Weiss, and Bruce Greenwald. A more extended version of some of the analysis in this paper is contained
in Stiglitz (1989b). I am indebted to Colin Mayer for his insightful comments and to the participants in the Conference on
'Economic Reconstruction in Latin America', at the Vargas Foundation, Rio de Janeiro, 7-8 August 1989, at which a version
of this paper was presented.

0266—903X/89$3.00 © OXFORD UNIVERSITY PRESS AND THE OXFORD REVIEW OF ECONOMIC POLICY LIMITED 55

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
OXFORD REVIEW OF ECONOMIC POLICY, VOL. 5, NO. 4

of the manager and those of the shareholders mightallocated the funds, banks continue to perform an
diverge was entertained, it was quickly dismissed:
important task, in ensuring that the funds are used
the discipline of the market place would ensureina the way promised by the borrower, and that the
congruence between the two. borrower, in responding to new contingencies, takes
into account the interests of the providers of capital.
The new paradigm stresses the importance of At the same time they provide these services, they
reduce the risks facing savers by allowing for
imperfect and costly information in the economy;
and the difficulties of enforcing contracts, of choosdiversification.
ing good managers and projects, and of providing
them with incentives—not only to work hard and toThe funds required for undertaking investments of
take appropriate risks, but also, more generally, to any scale are beyond the means of most entrepre
act in the interests of the shareholders. (Within theneurs. Banks and other financial institutions take
literature, these are referred to as the problems the
of relatively small savings of large numbers of
enforcement, adverse selection, and incentives.)
individuals, aggregate them together, and thus make
Much of the behaviour of the economy, the nature funds available for larger-scale enterprises. This is
of economic relations and institutions, can be inter
socially desirable because of the importance of
preted through this perspective. scale effects: if each individual was limited to the
investments he himself could finance, returns would
be correspondingly limited. This would be an
Capital markets and financial institutions, in par
ticular, can only be understood from this perspec
important role, even if all individuals were identi
tive. As we have come to understand capital cal, and the bank could, accordingly, allocate the
markets and financial institutions better within funds simply by randomly choosing one individual
developed countries, it has become clear that what
to receive the loan.
is remarkable is not that they do not work perfectly,
but that they work at all. But individuals are not identical. Some are better
managers than others, and some have better ideas.
Thus, I will argue that the LDCs should not set theirA central function of financial institutions is to
sights on imitating the capital markets of the most
assess which managers and which projects are most
developed countries, but rather should adapt them likely to yield the highest returns. Moreover, those
selves to the reality that capital markets will most
who have funds are not necessarily those who are
likely, if not necessarily, work poorly within their
most capable of using the funds; financial institu
country. Adopting this view suggests a major tions perform an important role in transferring
redirection of several policies which have been
funds to those for whom the returns are highest.
widely adopted within the third world. After out
Moreover, once the loan has been made, it is
lining in the next section the reasons for my belief
that capital market imperfections are endemic, and
important to monitor that the funds are spent in the
that governments are not capable of correcting thisway promised, and that the project is well m anaged.
'market failure', I tentatively put forward several
proposals. These two functions of financial institutions are
referred to as their screening and monitoring roles.2

II. ON THE IMPORTANCE OF CAPITAL

MARKETS III. ALTERNATIVE FINANCIAL
INSTRUMENTS
Capital markets perform several critical roles: they
aggregate savings and they allocate funds. In theThe form in which capital is provided has conse
process of performing these functions, they choose
quences both for how these screening and monitor
not only among competing sectors, but also among ing functions are performed and the behaviour of
competing management teams (firms). Having
those to whom the capital has been provided. The

: See Stiglitz and Weiss (1989).

56

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
 J. E. Stiglitz

three most important forms in which capital is decreases when they issue shares. This serves as an
provided are equity, long-term loans, and short important deterrent to issuing shares.3
term loans.
Because entrepreneurs do not have a fixed
From the perspective of the entrepreneur, equity commitment (and because they must share the
has two related distinct advantages. Risk is shared returns to their effort with the other shareholders)
with the provider of capital, and there is no fixed incentives are attenuated. Because shareholders
obligation for repaying the funds. Thus, if times are only get a fraction of profits, managers have an
bad, payments to the providers of capital are sus incentive to divert profits to their own use (not only
pended. The firm will not face bankruptcy, and will actions which border on the fraudulent, such as
not be forced to take the extreme measures intended giving favoured treatment to suppliers or buyers in
to stave off bankruptcy. From a social point of which managers have a strong financial interest,
view, equity has a distinct advantage: because risks but also managerial perks and salaries considerably
are shared between the entrepreneur and the capital above the managers' opportunity costs).4 Recent
provider, the firm will not normally cut back pro literature has stressed how imperfect information
duction as much as it would with debt finance, if and free rider problems provide theoretical
there is a downturn in the economy. (See Green explanations for why take-overs and other market
wald and Stiglitz, 19886.) mechanisms5 provide only limited discipline on
managerial behaviour, and consequently, for why
But there are some distinct disadvantages of equity. managers have considerable autonomy.6 These
Those entrepreneurs who are most willing to sell incentive issues have recently received consider
shares in their firms include those who believe, or able attention, as instance after instance of cash
know, that the market has overvalued their shares. rich oil companies squandering the extraordinary
There are, of course, good reasons for issuing profits they received during the years of high oil
equities—risk averse individuals with good profits come to light: in the US, Exxon with its half
investment projects, requiring more capital than billion dollar loss on Reliance, and Mobil with its
they have will also issue shares. But these individuals loss on Montgomery Ward are but two of many
and firms are mingled together with those who see instances. Indeed, the increase in value which has
an opportunity to cash in on the market ' s ignorance. been associated with corporate financial restructuring,
And unfortunately, the market cannot easily increasing firm debt, is often partly attributed to the
distinguish between the two. As a result, there is an fact that with high debt, managers are forced to
adverse signal associated with issuing new work hard—they have their backs to the wall.7
equities—on average, the value of firms' shares

3 For empirical evidence, see, for instance, Asquith and Mullins (1986); for a development of these theoretical arguments,
see Greenwald et al. (1984) or Myers and Majluf (1984).
4 Managers also often take actions which are directed more at their own welfare than the firms', e.g. the acquisition of
knowledge and skills which improves their market position. Managers not only expend resources to increase their outside
market value, but they also take actions which make it more difficult for the firm to replace them. This is referred to as
managerial entrenchment. See Shleifer and Vishny (1988).
5 Three other mechanisms for ensuring that those who get funds from others treat the providers of capital in the manner
promised should briefly be noted: (a) Reputation may be effective, if firms wish to re-enter the capital market to raise capital
again in the future. But reputation mechanisms are only effective if firms do wish to raise additional capital, and the adverse
signalling effect associated with new equity may make firms particularly reluctant to re-enter the equity market, at least for
a considerable period. (See Gale and Stiglitz, 1989.) Moreover, reputation mechanisms become particularly ineffective as
firms face threats of bankruptcy. (See Eaton et al. (1986) for a general discussion of these issues.) (b) Fraud and securities
laws may impose important constraints on how firms treat their providers of capital, (c) In traditional societies, trust (ethnic
ties) may provide an effective enforcement mechanism. In the process of development, however, these ethnic ties may be
weakened, impairing the efficiency with which capital markets function.
6 See, for instance, Stiglitz, 1972,1982; Grossman and Hart, 1980.
7 Robert Hall has, accordingly, referred to this theory of corporate finance as the 'backs-to-the-wall' theory of corporate
finance. Early studies emphasizing the role of finance in affecting managerial incentives include Jensen and Meckling (1976)
and Stiglitz (1974), who pointed out the close analogy between the traditional incentive concerns in the sharecropping
literature, and similar problems in modem corporate enterprises. For a more recent survey, see Jensen (1988).

57

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
OXFORD REVIEW OF ECONOMIC POLICY, VOL. 5, NO. 4

The disadvantages of equity seem, in most cases, haps

to remarkable that equities markets work as well
outweigh the advantages, even in more developedthey do.
as
economies. Relatively little capital is raisedby new
None the less, we must bear in mind the quite
equity issues, and even secondary equity issues
limited role that they play in raising capital in
(where a principal stockholder sells his shares,
developed countries. Hopes of raising substantial
either so that he can diversify his portfolio or spend
his wealth) are limited.8 amounts of capital in this form within LDCs appear
to me to be unreasonable.
But the more developed countries have several
distinct advantages in issuing equities that are not
(i) Short-term Loans
available in most LDCs. The existence of well
organized secondary markets for securities makes Short-term loans give the firm much less discre
tion: firms are on a short leash. They must make
equities particularly attractive. It increases liquid
ity and allows easy portfolio diversification. interest payments, and the bank can request its
funds back at each of the due dates. Thus, while
Moreover, the standard accounting procedures
nominally shareholders control the firm, minority
(enforced, in part, by the taxing authorities andshareholders
by exercise no effective control, while
government securities regulators) reduce the probbanks often exercise considerable influence over
lems posed by outright managerial cheating. They the firm ' s actions. Their refusal to renew a loan can
have serious adverse affects on the firm, and thus
make it more difficult for investors to be misled by
firms have a strong interest in complying with the
shady practices, including Ponzi schemes. Manag
demands of the banks.9 Overseeing loans is, of
ers can still rip off the firm—in one recent take-over
course, one of the bank's main economic roles—the
episode, they walked off with more than $100
million—but typically, the amount they take is role
but of monitoring noted above.
a small fraction of the firm's assets. In the early
There is an important difference between the con
days of modern capitalist economies, there were
numerous instances of stock-market scams. Given tractual arrangements and the true economic nature
this history, and the apparent ease with whichof the relationship. For the lender can only force the
stockholders can be taken advantage of, it is per borrower to repay the amount due if the borrower

8 The evidence is summarized in Mayer, 1989: new share issues, during the period 1970-85, as a percentage of net financing,
were negative for Finland, UK, and the US, and only 2.2 per cent for Canada and 0.6 per cent for West Germany.
Critics may point out that at certain selected times, stock markets have raised appreciable amounts of finance. (See, for
instance, Taggart (1985), who cites figures as high as high as 19 per cent for the period 1923-39.)
Taggart notes that the increase in equity issues, from 2+ per cent in the 1960s to 3 per cent in the 1970s, is largely accounted
for by public utility preferred stock issues; preferred stock does not suffer from some of the 'enforcement' problems associated
with common stock; moreover, utilities, because they are regulated and accordingly heavily monitored, do not suffer from
some of the other control problems associated with equities in other industries.
Moreover, the temporary success of a financial instrument in raising capital provides little evidence for its long-run viability.
It takes time for investors to leam about all the relevant attributes of a security, and it takes managers time to learn about all
the ways by which they can manipulate securities. Thus, income bonds looked as though they had risk sharing advantages
over traditional bonds, without the enforcement problems associated with common stock; yet investors eventually learned that
firms could manipulate the value of income, and that they were inadequately protected. The income bonds thus grew out of
favour. Junk bonds are an instrument which have recently enjoyed considerable popularity in the United States. They have
higher nominal yields than ordinary bonds; the question is, are those yields high enough to compensate for the additional risks?
Though experience with these bonds is sufficiently limited that one should be cautious in drawing conclusions, preliminary
evidence suggests that default rates on junk bonds that have been outstanding for a number of years are so high that actual
returns are no higher than on much safer bonds. A majorrecession in the United States, with a concomitant high default, would
turn investors away from junk bonds. Scandals in the UK equity market at the turn of the century contributed to the decline
in equity issues there. (See Kennedy, 1987, for an excellent account of these.)
Today, investors in LDCs bring to bear the full experience of how equities have been abused, even in societies with fairly
well functioning legal systems. This should make them wary about what would happen in LDCs. See Greenwald and Stiglitz
(19896) for a more extensive discussion of the develpment of financial markets and its relationship with changes in the legal
systems.
9 The view that banks may exercise more effective control over capital than minority shareholders is developed in Berle
(1926) and Stiglitz (1985).

58

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
 J. E. Stiglitz

has the funds; if he does not, he can force the bor perform its market clearing role. Market equilib
rower into bankruptcy. But there are often signifi rium may be—and frequently is—characterized by
cant economic costs of doing so, reducing the credit rationing. Thirdly, loan contracts will have
amount that the lender will eventually recover. a variety of other provisions other than interest
Hence, the borrower can often 'coerce' the lender rates, which will affect both the actions undertaken
into extending more credit—or at least not forcing by borrowers and the mix of loan applicants. While
the borrower to repay what is due. The borrower these non-price terms (such as collateral) may
knows this, and this may affect his behaviour. (This affect the extent of credit rationing, they do not
explains why banks are loathe to undercapitalize eliminate it (see Stiglitz and Weiss, 1986, 1987).
projects, knowing that they can be 'forced' to Moreover, banks may respond to defaults not by
extend further credit later.) The experience with increasing the rate of interest charged on subse
Third World Debt provides ample evidence of the quent loans, but by cutting off credit (Stiglitz and
importance of this phenomenon.10 The possibility Weiss, 1983).
of behaviour leading to subsequent 'forced loans'
provides banks with further incentives to monitor Thus, loan markets face different aspects of the
the borrowers. three problems of enforcement, selection, and in
centives than equity markets face. So long as the
Loan markets are distinctly different from the kinds firm does not go bankrupt, the 'enforcement' prob
of ' auction ' markets characterizing other goods and lem is not as serious: there is no necessity to have
services. Traditional textbook expositions charac to ascertain what the firm ' s profits are. The firm has
terized loan markets like the market for chairs or a simple commitment. But as we suggested, there
tables, with the price (the interest rate) equilibratingare still enforcement problems: in the event of
supply and demand. But this view is incorrect. Itbankruptcy, the bank must see that the borrower
misses the essential property of loans—they are not does not subvert funds; and, as we have argued, the
contemporaneous trade, but an exchange of fundsborrower may attempt to extract more funds from
by one party for a promise of a return in the future.
the lender, under the threat of bankruptcy.
It misses the essential heterogeneity of loan
contracts—the differences in the probability of deThe selection problem in the case of equity focused
fault. And it misses the essential informational on firms with low expected returns; in loan mar
problems—while the lender knows that different kets, there is also a selection problem, now focusing
borrowers differ in the probability of default, on he
those with high probabilities of default.
cannot perfectly ascertain which borrowers have
high default probabilities; and while the lender The incentive problem in the case of equity markets
knows that borrowers can undertake actions which focused on the attenuation of managerial incen
affect the likelihood that he gets repaid, he cannottives. Since borrowers can keep all of what the firm
perfectly monitor those actions.11 Three importantobtains in excess of what they have borrowed,
consequences follow: first, the process of allocat effort incentives are good. (And, as we have sug
ing credit (and monitoring its use) is not simply left gested, these incentives may be reinforced by firms'
to the market, with different borrowers competing concerns about bankruptcy.) But there are adverse
for funds by offering to pay higher interest rates. risk-incentives: firms pay insufficient attention to
B anks screen loan applicants. Secondly, because ofreturns in those contingencies where the firm goes
adverse selection and adverse incentive effects as bankrupt. When firms have a high likelihood of
sociated with increases in the interest rate (that is,default, these incentive distortions can become
as the interest rate charged increases, the 'quality'quite large.
of the mix of applicants changes adversely, and suc
cessful applicants undertake riskier projects),12 banksFinally, while in principle both providers of loans
may not raise interest rates even when there is an and equity have an incentive to monitor the actions
excess demand for credit. The interest rate does not of the borrower, lenders may be in a more effective

10 For an early theoretical discussion of these concerns with short-term debt, see Hellwig (1977) and Stiglitz and Weiss
(1981). For an analysis of third world debt from this perspective, see Eaton et al. (1986).
11 These arguments also apply to equities markets.
12 See Stiglitz and Weiss (1981).

59

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
OXFORD REVIEW OF ECONOMIC POLICY, VOL. 5, NO. 4

position for doing so, through their ability to with

There is a second reason that bonds play a relatively
draw credit. And while typically there are many small role in raising capital, even in major indus
equity owners, each firm has only one or, in anytrial countries. There is an adverse signal associ
case, a few providers of loans. This means that the
ated with a firm expressing an unwillingness to be
'public good' problem associated with put on a short leash. A firm which knows that it will
monitoring—of ensuring that the borrower takes be undertaking safe actions, and that its projects are
actions which are in accord with the interests of the
really good will be willing to subject itself to the
lenders—is less for loans than for equity.13 continued scrutiny of its bankers. Those who do not
want such close scrutiny include those who think
(ii) Bonds there is a high likelihood that eventually they will
fail to pass muster.15 Thus, even if there were some
Bonds represent a half-way house between short
economies associated with long-term commitments,
term loans and equity. With a bond, a firm has
theamarket might not provide these commitments.16
fixed commitment. It must pay interest every year,
and it must repay the principal at a fixed date.(iii)
As Consequences of Alternative Financial
a result, all the problems we have discussed above Arrangements
arise with bonds.
Thus, the form in which firms receive their finance
Bonds have one significant advantage—andaffects how risks get shared, how capital gets
disadvantage. Because the lender cannot recall theallocated, and most importantly, firm behaviour,17
funds, even if he is displeased with what the firm is and not just in the obvious ways. In textbook
doing, the firm is not on a 'short' leash, the way itexpositions, control of the firm rests with the share
is with loans. This has the advantage of enabling holders; managers act in the shareholders' inter
the firm to pursue long-term policies—but has theests; and control is transferred to debt holders when
disadvantage of allowing the firm to pursue policiesthe firm defaults on its loans. In practice, minority
which adversely affect the interests of bondholders. shareholders exercise little control or influence,
Bond covenants may provide some restrictions, butwhile banks, through their threat of refusing to
these generally only foresee a few of the possibleextend credit, can exercise considerable influence.
contingencies facing firms. The recent spate ofThe fixed obligations associated with debt finances
take-overs and corporate financial restructuring reduce managerial discretion. At the same time,
have significantly adversely affected bondholders,they make the firm—and its managers—bear risks,
and yet they had little or no say in the proceedings.14 which in the absence of the control/information

13 That is, since all those who provide aparticular form of capital are treated the same, if any one provider takes actions (e.g.
monitoring the actions of the firm) which increases his returns, all other members of the class are benefited equally. This gives
rise to a classic public goods problem: firm management is a public good (see Stiglitz, 1985). Shleifer and Vishny (1988)
present evidence that firms in which equity ownership is concentrated actually do perform more in accord with the interests
of shareholders.

14 Of course, in the future, bond contracts will include provisions designed to protect the bondholders against this kind of
financial restructuring. But it is essentially impossible to protect bondholders against all actions which might be devised which
would or could adversely affect bondholders. So long, however, as managers/equity holders retain powers of residual control,
innovative entrepreneurs will continue to find ways by which they can 'rob' bondholders; and as these practices spread, bond
covenants will be devised to protect the bondholders against these particular abuses.
15 In the more developed countries, the bond rating agencies provide a monitoring function akin to that provided by banks
for short-term credit. However, the bond rating agencies often have access only to publicly available information, while banks
may require borrowers to disclose much more information before they will be willing to extend further credit. Moreover, a
reduction in a firm's credit rating is important mainly if the firm wishes to raise additional credit by issuing new bonds or equity.
(Presumably banks, because they already have access to superior information, would find little additional information
conveyed by a reduction in the firm's credit rating.)
16 At the same time, it must be recognized that the focus on short-term performance may have adverse long-term effects.
17 Note that in the standard neo-classical theories, issues of control just do not arise: the manager simply takes actions which
maximize the expected value of the firm. We have seen, however, that the interests of managers and those of shareholders
may conflict. By the same token, the interests of debtors and equity may differ (see, for instance, Stiglitz, 1972), and even
the interests of different equity owners are likely not to coincide (see Grossman and Stiglitz, 1977, 1980¿>).

60

This content downloaded from

119.152.10ff:ffff:ffff:ffff on Thu, 01 Jan 1976 12:34:56 UTC
All use subject to https://about.jstor.org/terms
 J. E. Stiglitz

problems, should and presumably would have been incentives) to which we have called attention. There
spread through the market. And consequently the may exist government policies which will enhance
firm (and its managers) act in a more risk averse the capability of the market economy to raise and
manner than they otherwise would have, with obvi allocate capital. With this view in mind, I want to
ous deleterious consequences for the firm's ex discuss several possible policies. I want to empha
pected return, and not so obvious but no less size the tentative nature of this discussion: the
important deleterious consequences for the macro central thrust of my paper is that alternative policies
economic behaviour of the economy.18 need to be evaluated from a perspective which takes
into account the central features of capital markets,
as I have described them.
IV. POLICY IMPLICATIONS
Banks versus securities markets as sources of funds.
The first, and most obvious implication of our
Allocating capital is thus a much more complicated
matter than the simple 'supply and demand' analysis
paradigmis that the LDCs must expect that firms
suggests. Unfortunately, much of the simplistic
within their economies will have to rely heavily on
advice given by 'Chicago' economists is based on
bank lending, rather than securities markets, as
the hypotheses that markets for capital are sources of funds. While it may do little harm for
just like
markets for chairs and tables; that free governments to try to promote the growth of secu
markets—whether for chairs, tables, or rities markets, both markets for equities and long
capital—ensure Pareto efficient resource allocations;
term bonds, these are likely to provide only a small
and that policies that move the economy closer to of the funds firms require. If investors are
fraction
free market solutions are welfare enhancing. All
inadequately protected, by strong securities and
fraud
three of these presumptions are incorrect. We havelaws, and a judiciary which can fairly and
already argued against the first. And thereeffectively
is no enforce such laws, there is a high likeli
intellectual foundation for either of the other two.
hood of abuses; the resulting loss of investor con
fidence may have repercussions well beyond the
The second best theorems of Meade (1955) and securities directly affected.
Lancaster and Lipsey long ago showed that in
economies in which there were some distortions, Since reliance almost inevitably will be primarily
removing one distortion may not be welfare en placed on bank lending, it is important for govern
hancing. While they did not have in mind the kinds ments to take actions which improve the efficiency
of problems with which we are concerned here, the of the banking system. For instance, having well
basic lesson remains valid in this context as well.defined property rights (say in land) provides a
source of collateral, which facilitates bank lending.
More fundamentally, Greenwald and Stiglitz (1986,A judiciary which can quickly deal with defaults, at
1988a) showed that economies in which markets low costs, allowing the lender to seize and dispose
are incomplete or in which information isof the collateral again enhances the willingness of
imperfect—that is, all economies—are, in general,banks to lend. Such reforms may seem relatively
not constrained Pareto efficient; that is, there aluncontroversial, compared to the suggestions be
most always exists some form of quite limited govlow.
ernment intervention (e.g. taxes and subsidies, which
respect the limitations on markets and information) Government Credit Markets. Many governments
which is Pareto improving.19 have seen the task of allocating capital as being too
important to be left to the private sector. The
Thus, an analysis of government policies towardssocialist platform typically has the nationalization
capital markets needs to take into account theof banks and other financial institutions high on its
fundamental problems (enforcement, selection,agenda.

18 In particular, the economy will be more sensitive to a variety of shocks which it may experience; small shocks may be
translated into large macroeconomic fluctuations. See Greenwald and Stiglitz, 1988b. The long-run growth path of the
economy may also be adversely affected. See Greenwald and Stiglitz, 1989a.
19 They show that several widely discussed examples in the literature (e.g. the Arrow-Debreu model, or the Diamond (1967)
stock market model) represent special cases in which the market is Pareto efficient.

61

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
OXFORD REVIEW OF ECONOMIC POLICY, VOL. 5, NO. 4

The central problems which I have discussed are noWhat is at issue is not just corruption (though that
less problems within the public sector than in theplays a role as well), but rather judgements about
private. But to make matters worse, the governprudent risks. It is evidently extremely difficult for
ment often does not have the incentives to ensure bank regulators to monitor banks effectively. One
that it does a good job in selecting and monitoring
must largely rely on market forces to ensure that
loans. The deep pocket of the government meansbanks take prudent actions. What regulators can do
that any losses can easily be made up. Moreover,is to try to ensure that the banks have an incentive
since economic criteria are often supplemented to take prudent actions. The maintenance of repu
with other criteria (saving jobs, regional developtation is one such incentive. But the cost of losing
ment), losses can be blamed not on an inability toone's reputation is obviously larger for a large
make judgements about credit worthiness, but on international bank, than for a small local bank.
the non-economic criteria which have been im High equity (net worth) also may be effective.
posed. The absence of the check provided byLocal the banks may find it difficult to raise the re
market test means that credit can be allocated on quired
the equity.
basis of political favouritism: the subsidy associ
ated with charging a lower rate of interest thanThese
the arguments suggest that foreign banks and
riskiness of the loan merits is hidden.20 firms may be more reliable in allocating capital
efficiently than domestic banks and firms. To put
Foreign investment and banks. Many governments
it another way, establishing a reputation is like any
of LDCs have been particularly loath to allow
other investment. The process of allocating
capital—when due concern is taken for the requi
foreign banks to play a major role. I want to suggest
that this policy may be misguided, but in anysite
case,
incentives if it is to be done well—is a capital
needs to be re-examined from the perspectives
intensive process, and foreign banks (and other
provided in this paper. international companies) may have a comparative
advantage in that process.
In all countries, the ratio of banks ' net worth to their
liabilities is usually veiy small. In a sense, banks
At the same time, there may be an infant industry
can be viewed as highly leveraged firms. Highly argument for protection, and, in particular, for
leveraged firms are particularly prone to undertak
limiting external capital flows (which allow foreign
ing risks which are not in the interests of theirinstitutions to serve the role of intermediation)22
lenders—here those who have deposited fundsand withthe operation of foreign banks domestically.
them. So long as savers have a choice between domestic
and foreign banks, at comparable terms, they will
In the United States (and many other countries) the the latter. (Lack of) reputation serves as an
choose
government provides depositors with insurance.
effective entry barrier for domestic banks: to com
When the idea of such insurance was first broached
pensate for the lack of reputation they cannot pay a
to President Roosevelt, he reacted strongly negatively,
higher interest rate, for that (in the by now familiar
pointing out (to use our modem terminology) the would exacerbate both the moral hazard and
way)
moral hazard (incentive) problems to which that
adverse selection problems.
insurance gives rise. Though he eventually relented,
with hindsight, we can see how right he was!21
Domestic firms are not only at a reputation disad
Banks which undertake greater risk can offer greater
vantage; they are also at a risk disadvantage. Inter
interest rates to depositors, who can, with impunity,
national firms can diversify over a wide portfolio.
turn over their funds to the bank. These banks
Even if the domestic banks have a portfolio of
attract funds away from more prudent banks. A that is widely diversified among domestic
assets
kind of Gresham's Law works with a vengeance.
risks, the common (country) risks which affect all

20 Moreover, even in the absence of corruption, if rationing is optimal (as Stiglitz and Weiss (1981) show it may be), the
ability to choose among loan applicants gives the government an enormous amount of power.
21 In the United States, at the present time, not only do a majority of savings and loan institutions have negative net worth
(if their assets were valued at current market value), but so do a significant fraction of the major banks.
22 In several LDCs, capital outflows roughly equal capital inflows. It is as if funds went to international banks to b
intermediated, and then were returned to the country of origin.

62

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
 J. E. Stiglitz

of them (exchange risks and other macroeconomic make nationalization less likely and that make it
risks) make their portfolios riskier. Hence, even more likely that, should nationalization occur, they
with the same 'reputation' and the same equity, can recover their capital.
investors might prefer foreign firms.
While these arguments might suggest a role for
While foreign firms may thus have an advantage government credit markets, the caveats we ex
within the capital market, they may have an infor pressed earlier suggest that other forms of indirect
mational disadvantage—they may find it more dif subsidy may be more effective. Restrictions on
ficult to respond to the particular situations which foreign banks and on capital flows out of the
arise in the country.23 That is why there is much to country (impeding the efficiency of the secondary
be gained from a country having its own entrepre capital market) may be one way of channelling
neurs.24 But entrepreneurship is, in part, learned, funds to domestic entrepreneurs and of subsidizing
and to undertake the learning requires capital. And domestic banks and corporations. Such broad
we have explained why it is that domestic entrepre restrictions provide domestic investors with incen
neurs and banks may find it difficult raising the tives to allocate funds to the best domestic projects/
requisite capital. entrepreneurs, and if there is broad enough compe
tition within the domestic economy, the rents ob
Note that a standard argument against the infant tained by domestic firms will be limited.
industry argument simply does not apply in this
context: if the idea is a good one, the firm should Another caveat is in order: as always, a concern
be willing to sell at a loss, until its costs are down needs to be expressed that restrictions are not used
to a level at which it could compete effectively. For simply to protect domestic monopolies. Thus, if
to sell at a loss, the firm must borrow or raise equity, one or two banks dominate the domestic banking
and it is precisely the inability of firms to borrow or industry, restrictions on foreign banks may simply
raise equity which is our concern here. serve to protect those firms' monopoly rents. Those
firms may not be particularly efficient allocators of
Moreover, there may be a distinct difference between capital, and the disparity between their interests and
private and social returns, both to entrepreneurship a broader sense of national interest may be no less
and to providing capital to new entrepreneurs. than the corresponding disparity for foreign banks.
Private investors (banks), for instance, are only Since inmany LDCs the domestic banking sector is
concerned with that fraction of the total returns far from competitive, policies aimed at locking out
foreign owned banks located within the country
which they can appropriate; society, more broadly
conceived, is concerned with the total returns to themay be particularly inadvisable.
project which accrue within the country (thus
Secondary and primary financial markets. Finan
excluding the surplus returns which may accrue to
foreign investors.)25,26 cial markets consist of a host of interrelated institu
tions. Much of the activity of financial markets is
centred around the exchange of ownership claims.
More broadly, foreign banks, in allocating capital,
will have different objectives than those of domesticI refer to these as ' secondary financial markets'. A
small fraction of the resources of the financial
banks, so that the disparity between social and
private returns may be particularly large. Foreign
industry is directed at its primary function, raising
banks may be particularly concerned withand allocating capital (the primary financial mar
nationalization, and thus may provide capital to ket). The latter has important economic effects,
sectors which appear relatively immune from
but, still, only a relatively small fraction of all in
nationalization, and in forms (with restrictions) thatvestment funds are raised through the market.

23 This argument may not be a compelling one against foreign banks located within the LDCs.
24 There are undoubtedly other reasons as well, such as national pride.
25 Stiglitz and Weiss (1981 ) argued that in their model of credit rationing, there was a distinct disparity between social and
private returns.
26 Hoff (1988) argues, for instance, that when an entrepreneur undertakes a new project, it conveys information to other
entrepreneurs about the idiosyncratic properties of the country ' s production technology, returns which that entrepreneur cannot
appropriate.

63

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
OXFORD REVIEW OF ECONOMIC POLICY, VOL. 5, NO. 4

Keynes likened the secondary financial market (the

In the previous section, I argued that restrictions on
stock market) to a beauty contest, in which the the secondary capital maikets—on the free flow of
judges were concerned not with judging who was funds abroad—may have some advantages in en
the most beautiful contestant, but who the othercouraging the development of a domestic financial
judges would think would be judged the most sector. To economists used to hearing the conten
beautiful contestant (or, perhaps more accurately,
tion that governments should try to 'free up' mar
he should have said, who the other judges would kets, this argument may seem strange.
judge the other judges to judge to be the most
beautiful contestant. . .)• Others (Stiglitz, 1982)
One of the important lessons of the theory of the
have suggested that the stock market might secondbe best, to which I referred earlier, is that when
thought of as a gambling casino. It is impossiblethere are some important distortions in the econo
to reconcile behaviour in this market with rational,
my, removing one distortion may not be welfare en
risk averse individuals. hancing. In most LDCs, there are many distortions.
Indeed, as we argued earlier, in economies with in
complete risk markets and imperfect
While the ability of individuals to trade on the
secondary market undoubtedly makes securitiesinformation—that is, in all economies—there is no
more attractive, Keynes, as well as many more presumption that market allocations will be (con
recent authors (such as Hirschleifer, 1971, and
strained) Pareto efficient, and a fortiori, there is no
Stiglitz, 1971) have suggested that much of the
presumption that making one market work more
short-term speculative activity has zero or negative
nearly like the 'ideal' market is welfare enhancing.
net social value. While it is true that the stock
market may be efficient, reflecting all available
For instance, McKinnon (1988) has argued persua
information,27 that information has tittle effectsively
on that flexible, unmanaged exchange rates
resource allocations. Firms do not and cannot rely
have imposed enormous risk burdens on producers
on the information (whatever that is) communi engaged in international trade, risks which they
cated by the stock market for making their produc
cannot divest adequately through futures markets.
tion and investment decisions (see Stiglitz, 1989a).
Our analysis of limited equity markets suggests that
One individual, by getting the information earlier
these risks may have real—and deleterious—effects.
than the other, may be able to 'trick' anotherSee, for instance, Newbery and StigUtz (1981,1984).
individual into buying a share from him, or selling
a share to him, but these trades only affect who By
getsthe same token, it is not apparent that 'freeing
society's resources; they do not affect the level
up'ofcapital markets, allowing funds to flow freely
production. They represent, in other words, private
abroad, is necessarily welfare enhancing. This is
rent-seeking activities. not the occasion to enter into a full-scale policy
debate on that issue. I want to emphasize, however,
I stress this because the two aspects of financial
that economic theory provides no presumption that
markets are often confused. Much of the recentfreeing up secondary capital markets is necessarily
innovations in financial markets have been conwelfare improving.
cerned with the secondary market. New instru
ments have been invented. Transactions can be All of this suggests that there are no easy policy
recorded more quickly. But improvements in the answers. In some cases, governments have (per
secondary markets do not necessary mean that the haps unintentionally) served to exacerbate the
economy functions more efficiently. (Indeed, Stiglitz problems we have identified rather than reduce
and Weiss (1989) have shown that some of the them, by subjecting the domestic banking industry
financial innovations, such as faster recording of to high taxes and arbitrary and capricious regula
transactions, may actually be unambiguously wel tion. In these cases, 'freeing up' the market would
fare reducing.) In particular, the primary financial seem to make good policy sense.
markets may not perform their roles any better.

27 Though if it were truly efficient in that sense, no one would have any incentive to collect information, and thus the only
information which would be reflected in the market price would be free (although in this case, that may not mean completel
worthless) information. See Grossman and Stiglitz (1976,1980b).

64

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
 J. E. Stiglitz

Multinationals. Many of the same arguments for firms to borrow (since the lower the riskiness of the
why foreign banks may be able to perform an environment, the more they can borrow while still
important role in allocating capital apply to multi facing a particular probability of bankruptcy), and
nationals. They have one advantage over banks: the willingness of banks to lend.
they typically provide capital in the form of (what
is in effect) equity. While equity has distinct These policies can be both microeconomic and
advantages over debt—it provides more effective macroeconomic in nature. Stabilizing the price of
risk sharing, and thus leads firms to act in a less risk export crops will not only have a direct effect on the
averse manner, resulting, in turn, in the economy producers of export crops (assuming that price and
being less sensitive to a variety of shocks—we have quantity are not too negatively correlated), but will
seen that LDCs are likely to face particular prob also have an indirect effect: the variability of
lems in establishing well-functioning equity mar income of the producers of export crops gives rise
kets. Thus, it may be desirable for governments in to variability in the demand for non-traded goods.
LDCs to recognize the important role that multina Stabilizing incomes within the rural sector will thus
tionals can play in the development process, rather result in increased production of non-traded goods.
than putting impediments in their way. (See Newbery and Stiglitz, 1981.)

Risk sharing by government. For the reasons I have

explained, equity markets are unlikely to provide V. CONCLUSIONS.
effective risk-sharing opportunities. Many govern
ments, by their tax policies, exacerbate the effects In the past two decades there has been a major shift
of limited equity markets, for the government shares in the prevailing economic paradigm, reflected in
in the profits, but shares in the losses to a much our views of economic policy in general, and devel
more limited extent. As Domar and Musgrave opment economics and policy in particular.
(1944) long ago recognized, if the government fully
shares in gains and losses, it can actually encourage Earlier discussions focused on the debate between
risky investment; in effect, the government enters those who believed in efficient, competitive
into every investment as a silent partner.2® Though markets—for developing as well as developed
this is not the occasion to provide a detailed techni countries—and see government as a major imped
cal proposal of how this may be done, I should note iment to the efficient functioning of the economy;
that there are several ways in which governments and those who saw pervasive market failures requiring
can share risk much more effectively than they do government intervention. Among the central market
at present.29 failures which they cited was the absence of a
complete set of futures and risk markets,30 and
Government risk reduction strategies. In addition, accordingly one of the central responsibilities of the
there are policies which the government can under government was to plan and co-ordinate invest
take which reduce the riskiness of the environments ment activities. In the years following the Second
in which firms operate, and given the limited op World War, governments of newly independent
portunities for risk sharing provided by markets, countries set up Ministries of Planning to fulfil their
this can provide a strong stimulus for the economy. responsibilities and to facilitate the development
In particular, it can increase both the willingness of process.

28 More recently, Auerbach and Poterba (1987) have emphasized the importance, within the United States, of the provisions
limiting loss deductibility.
29 The important difference between the government acting as a silent equity partner, through the tax system, and the
government acting as a source of credit (as described above) needs to be recognized: in the latter case, the government is given
discretion, in the former case, the 'partnership' arrangement is automatic. While this partnership arrangement obviously
affects incentives (attenuating effort incentives, accentuating risk incentives), the question is, on balance, are these incentive
effects positive, or, if negative, sufficiently small to outweigh the government's revenue gain?
30 As noted earlier, the Fundamental Theorem of Welfare Economics, which represented the formalization of Adam Smith's
notion of the Invisible Hand, requires that there be a complete set of risk and futures markets. Only under those conditions
will competitive markets ensure economic efficiency.

65

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
OXFORD REVIEW OF ECONOMIC POLICY, VOL. 5, NO. 4

But the absence of futures and risk markets was not opportunities (the selection or screening function),
pure happenstance. It reflected more fundamental and to ensure that those funds are well used (the
problems—including problems of imperfect infor monitoring function). We need to think more about
mation and costly contract enforcement—which what kinds of institutions can most effectively
affected all economies. The recognition of the limi perform these functions. Centralized government
tations of the development planning process coin bureaucracies and large public credit institutions
cided with the recognition of these limitations of may be poorly situated to perform those functions.
the standard economic paradigm. Within devel But there may be ways in which the government can
oped countries, it was recognized that labour, capi assist in the development of a variety of institutions
tal, and product markets worked—in many in which can play an important role.
stances at least—in a manner markedly different
from that depicted by the conventional competitive But much of this paper is predicated on a more
demand and supply analysis. While this paper has pessimistic appraisal of the potential role of finan
focused on the problems associated with financial cial institutions in the development process. It has
markets, leading to credit and equity rationing, argued that they play a limited role even within
similar analyses have been conducted of labour and well-organized developed countries, and that their
product markets. These problems are, if anything, role within the LDCs is likely to be even more
more pervasive and more prominent in LDCs than circumscribed. Hence, government policies should
in developed economies. be directed at mitigating the consequences of these
inherent—and important—limitations of financial
We now recognize that, particularly for small open institutions within LDCs. What might be called
economies, the problems of macro-economic co 'second' or 'third' best policies have to be devel
ordination stressed in the earlier development plan oped. Many current government policies fail to
ning literature may be far less important than the recognize these limitations which face both the
microeconomic problems of selecting (quite spe government and the private sector. I have put
cific) projects and choosing good managers to forward some quite tentative proposals which sug
manage those projects. One of the functions of the gest some ways in which government policy can be
economy's financial institutions is not only to raise designed to reflect the broad set of concerns which
capital, but to channel funds to the most profitable I have raised.

REFERENCES

Asquith.P. andMullins, D. W. (1986), 'Equity Issues and Offering Dilution', Journal of Financial Econ
61-89.

Auerbach, A. and Poterba, J. (1987), 'Tax Loss Carryforwards and Corporate Tax Incentives', in Feldstein, M.
(ed.), The Effects of Taxation on Capital Formation, Chicago, University of Chicago Press.
Berle, (1926), 'Non Voting Stock and "Bankers" Control', Harvard Law Review.
Diamond, (1967), 'The Role of a Stock Market in a General Equilibrium Model with Technological Uncertainty',
American Economic Review, 57, 753-76.
Domar, E. and Musgrave, R. (1944), 'Proportional Income Taxation and Risk Sharing', Quarterly Journal of
Economics, 58, 388-422.
Eaton, J., Gersovitz, M., and Stiglitz, J. E. (1986), 'The Pure Theory of Country Risk', European Economic
Review, 30,481-513.
Gale, I. and Stiglitz, J. E. (forthcoming), 'The Informational Content of Initial Public Offerings', Journal of
Finance.

Greenwald, B. and Stiglitz, J. E. (1986), 'Externalities in Economics with Imperfect Information and Incomplete
Markets', Quarterly Journal of Economics, 101,229-56.

66

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
 J. E. Stiglitz

Greenwald, B. and Stiglitz, J. E. (1988a), 'Pareto Inefficiency of Market Economies: Search and Efficiency Wage
Models', American Economic Review—Papers and Proceedings, 78, 351-5.
— — (19886), 'Financial Market Imperfections and Business Cycles', NBER Working Paper No. 2494.
— — (1989a), 'Financial Market Imperfections and Productivity Growth', NBER Working Paper No. 2365.
— — (19896), 'Information, Finance and Markets: The Architecture of Allocative Mechanisms', paper
prepared for International Conference on the History of Enterprise: Finance and the Enterprise in a
Historical Perspective, Terni, Italy.
— — and Weiss, A. (1984), 'Informational Imperfections and Macroeconomic Fluctuations', American
Economic Review, May, 194-9.
Grossman, S. and Hart, O. (1980), 'Takeover Bids, the Free Rider Problem, and the Theory of the Corporation',
Bell Journal, 35(2), 42-04.
— and Stiglitz, J. E. (1976), 'Information and Competitive Price Systems', American Economic Review, 66(2),
246-53.
— — (1977), 'On Value Maximization and Alternative Objectives of the Firm', Journal of Finance, 32(2),
389-402.
— — (1980a), 'On the Impossibility of Informationally Efficient Markets', American Economic Review,
70(3), 393-408.
— — (19806), 'Stockholder Unanimity in the Making of Production and Financial Decisions', Quarterly
Journal of Economics, 94(3), 543-66.
Hellwig, M. (1977), 'A Model of Borrowing and Lending with Bankruptcy', Econometrica, Vol. 65,1876-906.
Hirschleifer, J. (1971), 'The Private and Social Value of Information and the Reward to Incentive Activity',
American Economic Review, 67,561-74.
Hoff, K. (1988), 'Essays in the Theory of Trade and Taxation Under Incomplete Risk Markets', unpublished
doctoral dissertation, Princeton University.
Jensen, M. (1988), 'Takeovers: Their Causes and Consequences', Journal of Economic Perspectives, 2,21-48.
— and Meckling, W. H. (1976), 'Theory of the Firm: Managerial Behavior, Agency Costs and Ownership
Structure', Journal of Financial Economics, 3, 305-60.
Kennedy, W. P. (1987), Industrial Structure, Capital Markets, and the Origins of British Economic Decline,
Cambridge, Cambridge University Press.
McKinnon, R. (1988), 'Monetary and Exchange Rate Policies for International Financial Stability: A Proposal',
Journal of Economic Perspectives, 2(1), 83-105.
Mayer, C. (1989), 'Myths of the West: Lessons from Developed Countries for DevelopmentFinance', World Bank
Working Paper.
Meade, J. E. (1955), Trade and Welfare: Mathematical Supplement, Oxford, Oxford University Press.
Myers, S. C., and Majluf, N. S. (1984), 'Corporate Financing and Investment Decisions When Firms Have Infor
mation that Investors Do Not ', Jour nal of Financial Economics, 11,187-221.
Newbery, D. and Stiglitz, J. E. (1981), The Theory of Commodity Price Stabilization, Oxford, Oxford University
Press.
— — (1984), 'Pareto Inferior Trade', Review of Economic Studies, 51(164), 1-13.
Shleifer A, and Vishny, R. (1988), ' Managerial Entrenchment: The Case of Manager-specific Investments ', paper
presented at Olin Conference on Economic Organizations, Princeton.
Stiglitz, J. E. (1971), 'Perfect and Imperfect Capital Markets', paper presented to Econometric Society Meetings,
New Orleans.
— (1972),'Some Aspects of the Pure Theory of Corporate Finance: Bankruptcies and Take-Overs', Bell
Journal of Economics, 3(2), 458-82.
— (1974), 'Incentives and Risk Sharing in Sharecropping', Review of Economic Studies, 41, 213-55.
— (1982), 'Information and Capital Markets', in W. F. Sharpe and C. Cootner (eds.), Financial Economics:
Essays in Honor of Paul Cootner, Englewood Cliffs, New Jersey, Prentice Hall.
— (1985), 'Money, Credit and Banking Lecture: Credit Market and the Control of Capital', Journal of Money,
Credit and Banking, 17(1), 133-52.
— (1989a), 'Using Tax Policy to Curb Speculative Short-Term Trading', Conference on Regulatory Reform
of Stock and Futures Markets, Columbia University.
— (19896), 'The Development of Financial Markets for Economic Development', lecture presented at a
conference by the Vargas Foundation, 'The Economic Reconstruction of Latin America', in Rio de Janeiro,
August 1989.

67

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms
OXFORD REVIEW OF ECONOMIC POLICY, VOL. 5, NO. 4

Stíglitz, J.E.andWeiss,A.(1981),' Credit Rationing in Markets with Imperfect Information ', AmericanEconomic
Review, 71, 393-410.
— — (1983), 'Incentive Effects of Terminations: Applications to the Credit and Labor Markets', American
Economic Review, 72,912-27.
— — (1986), 'Credit Rationing and Collateral', Recent Developments in Corporate Finance, 101-35, Cam
bridge University Press.
— — (1987), 'Macroeconomic Equilibrium and Credit Rationing', NBER Working Paper No. 2164.
— — (1989), 'Banks as Social Accountants and Screening Devices and the General Theory of Credit
Rationing', Essays in Monetary Economics in Honor of Sir John Hicks, Oxford, Oxford University Press.
Taggart, R. A. Jr (1985), 'Secular Patterns in the Financing of US Corporations', in B. M. Friedman (ed.),
Corporate Capital Structures in the United States, National Bureau of Economic Research Project Report,
Chicago, University of Chicago Press.

68

This content downloaded from

119.152.101.179 on Fri, 16 Oct 2020 03:48:01 UTC
All use subject to https://about.jstor.org/terms