Essays in Financial Market Imperfections

Abstract

A widely accepted feature of financial markets across the world is that there are limits to access credit. While this problem is extremely acute at times of economic crisis and recession, it is also prevalent at times of robust economic growth. When investment opportunities in an economy are strong, outside banks seek to enter the markets in search of higher profits. Presumably, removal of regulatory barriers that facilitates the entry of foreign banks should increase access to credit for local firms. However, opinion is divided as to whether this actually occurs in practice. On the other hand, when firms are faced with economy-wide crisis, liquidity constraints are fairly acute. In such circumstances, perfect capital markets would require that scarce capital be allocated to its highest marginal return making wealth distribution irrelevant. Here too, previous work suggests that the functional efficiency of capital markets depends on the distribution of corporate control in an economy. The first two essays are aimed to gain a better understanding of the first problem, primarily from a theoretical standpoint, while the third essay is an empirical study of issues that govern the second problem. The first two essays show that asymmetric information between incumbents and entrant banks can work as an endogenous barrier to entry. Moreover, entrant banks find it easier to secure markets with better borrower quality but have to engage in costly screening where firm quality is poor, as is the case for the small-firm market. The third essay finds that, contrary to popular belief, the distribution of corporate control mattered little in the resolution of financial distress for firms that were affected by the crisis in East Asia. The empirical results conclude that financial considerations were predominant in the resolving firm-specific distress.