Academic journal article Journal of Economic Cooperation & Development

Investment and Financial System Design for Firms in Malaysia

Academic journal article Journal of Economic Cooperation & Development

Investment and Financial System Design for Firms in Malaysia

Article excerpt

This paper investigates the impact of financial system design on investment. It is aimed to provide additional empirical evidence based on the original paper by Demirguc-Kunt and Maksimovic (2002). The firm-level data are used for Malaysian listed firms between 2000 and 2007. This paper also utilizes the same estimation method i.e. generalised method of moments for panel data, as proposed by Arellano and Bond (1991). The findings show that: first, the Risk Weighted Capital-adequacy Ratios and Core Capital Ratios have negative impact on investment of firms. This can be explained from Government intervention which is designed to encourage bank's lending to firm investment. Second, the capital market variables show negative effects on investment due to the presence of capital market imperfections. Finally, both gross domestic product and foreign direct investment show positive impacts on investment. This result is consistent with previous empirical evidence in which a firm is likely to have a larger investment when its investment opportunities are good. It is recommended to the policy maker to intervene the related policy with investment and financial design. It is because both variables are interrelated each other and give impact to the growth of economy in a country.

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1. Introduction

The financial system is important in stimulating economic growth. It can be seen from the policy perspective that is aimed for expanding the financial system to foster growth. The contribution of financial system to economic growth can be seen in different aspects, such as in mobilizing savings, allocating these savings and competing investment projects. As a result, some countries concentrate on developing the banking system while others develop the capital market. The related issue here is how do firms in developing countries choose between debt (bank design) and equity (capital market design)? What role do capital markets play in this choice? Is this choice influenced by the development level of a country stock market? Many theoretical and empirical analyses show that these tasks are different in a market-based system and in a bank-based system. Most countries have both financial intermediaries (e.g., banks) and markets (e.g., stocks) but their relative importance differs.

Furthermore, important differences seem to exist between the developed and developing countries (Atkin and Glen, 1992; Agarwal and Mohtadi, 2004). According to Atkin and Glen (1992), these differences can be found in firms of G7 countries whose funds are generated from internal sources, while firms in developing countries, generate their fiinds from external sources (bank loans and equity). The statistics show that internal finance generates between 12 to 58 percent of the total finance in the developing countries and between 52 and 100 percent among the G7 countries. It means that, both the debt (bank design) and equity (capital market) are important sources for firms' investment in developing countries. It is different to developed countries where most of their investment comes from internal sources. Hence, in the developing countries the banking systems complement the stock market activity in increasing the firm investment.

In addition, to illustrate, at one extreme, the United State (US) has market-based financial systems where stock markets play an important role, while at another extreme, Germany has bank-based systems where banks dominate credit allocation. As in the German financial systems, Japan businesses were often subjected to the strong influence of great banks that played major roles in corporate control and governance. These banks were generally consensual keiretsu decision-makers. A horizontal keiretsu shows relationships between bank and industries, normally centred on a bank and trading company, for example, Mitsubishi. In Germany, the banks were often viewed as the primary decision makers (Allen and John, 1991). …

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