Corporate Finance
Myths and models

Despite numerous studies of the contribution of financial systems to economic performance, many fundamental misunderstandings about the structure of different systems remain. In Discussion Paper No. 948, Research Fellows Jenny Corbett and Tim Jenkinson assess the relative importance of different sources of finance to the enterprise sector in Germany, Japan, the UK and US to determine whether their patterns have converged since 1970. They maintain that the common practice of computing gearing ratios from company accounts is inadequate for international comparisons since investment is itself a flow concept. They use national income accounts data on flows of funds instead to construct comparable measures of the sources and uses of net finance for investment in physical assets. They use these to show that internal sources of net finance dominated in all four countries. Only 10% of finance was raised from external sources in Germany, the UK and the US, whose proportions of bank finance were roughly equal, although the proportion for Japan was higher.

Corbett and Jenkinson then consider changes in the financing patterns over successive five-year periods and relate the financing of physical investment to the business cycle. Their data expose a number of common myths, including the conventional wisdom that the UK and US are `market-based' and Germany and Japan `bank-based' systems. Most conventional models of convergence towards an `Anglo-US bench-mark' assume that the shares of market sources in corporate finance in the UK and US are themselves rising, but both countries' reliance on market sources has in fact fallen while German dependence on them has not changed, so the systems are becoming similar if not actually converging. Market sources have consistently provided larger shares in Japan, which witnessed a rise in the share of internal finance in the late 1970s, while the well-documented shift from bank to other market sources has been rather exaggerated. Corbett and Jenkinson also demonstrate that establishing a link between investment performance and the use of external sources of finance across countries is difficult. Low shares of external finance now appear to relate to slower growth of investment in the UK; a similar relationship may have existed in Japan in the 1970s but does not apply today and has never existed in Germany. They suggest that this might be better examined using micro panel data with a more rigorous econometric treatment.

The Financing of Industry, 1970-89: An International Comparison
Jenny Corbett and Tim Jenkinson

Discussion Paper No. 948, May 1994 (FE/IO)