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Firms' Financing Choices in Bank-Based and Market-Based Economies

The late 1980s and 1990s witnessed unprecedented developments in the financial sector of emerging economies. Emerging markets became more open and integrated with the rest of the world. After lifting restrictions on capital movements, countries received record high levels of capital inflow. During the 1970-80s, capital flows were mainly directed to governments or to the private sector through the banking system. Whereas, in the 1990s, capital flows took the form of foreign direct investment and portfolio flows, including bond and equity flows.

Companies in emerging markets are now participating in international financial markets. Equity trading is shifting from local domestic markets to international markets. As financial markets became more global, a remarkable series of financial crises occurred, with significant spillover effects across countries. Countries open to financial flows were severely affected by swings in international financial markets.

The increased integration with world capital markets and the recent crises have generated a debate on the benefits of financial integration and the role of domestic financial systems. Does the integration with world capital markets provide better financing opportunities for local firms? If so, can all firms benefit equally? Should countries promote the development of the domestic financial system or should they fully integrate with international capital markets? In light of the increasing globalization, what type of domestic financial systems is more adequate for financial development? What type of financial systems can better complement and ease the inevitable integration with world financial markets? What type of financial system can better cope with financial crises?

In a separate paper, Schmukler and Vesperoni (2000), we concentrate on the effects of globalization on firms' financing choices. In the present paper, we study the relation between the type of domestic financial sector and firms' financing opportunities. More specifically, we analyze whether the relation between firms' financing choices and firms' characteristics differs across financial systems. Additionally, we study whether the effects of integration and financial crises on firms' financing ratios are different in bank- based and market-based economies.

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Firms' Financing Choices in Bank-Based and Market-Based Economies