Growth, Poverty, and Capital Structure Effects of Financial Development

Author

Ficawoyi Donou-Adonsou, Southern Illinois University CarbondaleFollow

Date of Award

8-1-2014

Degree Name

Doctor of Philosophy

Department

Economics

First Advisor

Sylwester, Kevin

Abstract

Financial development has been on target in the literature for the past two decades. Different aspects of this topic have been debated, most notably its growth aspect that is widely discussed. The main conclusion of this discussion is that financial development can cause growth as well as growth can cause financial development. Although poverty has been also discussed, not a lot of studies have tried to understand the causal relationship between financial development and poverty. Moreover, when talking about financial development, most studies focus on bank finance and equity finance as the main channels of financial development. The advent of microfinance lets to think about the potential role these institutions can play in a countrywide economy. Many studies have found evidence of increases in consumption, savings, and poverty alleviation as the results of microfinance loans at the community level, but not much has been said at the countrywide level. Some theoretical papers have found aggregate level evidence of microfinance, but this evidence has not been yet under empirical investigations. The first two chapters of this dissertation empirically investigate respectively growth and poverty effects of microfinance and compare them with traditional banks using the financial development framework. Chapter 1, entitled "Growth effect of banks and microfinance: Evidence from developing countries," considers both the banking and microfinance sectors and analyzes their growth effect using traditional measures of financial development such as credit to GDP ratio. Using a panel of 72 developing countries over the period 2002-2011, we find with the system GMM estimator that microfinance loans do exhibit strong growth effect. As for bank loans, there is no strong evidence of growth effect. However, the analysis from the investment perspective tells quite the opposite story: Bank loans do have investment effect, while microfinance loans do not show strong evidence of investment effect. These results suggest that microfinance loans are not primarily invested as physical capital, but could increase total factor productivity, whereas banks may have been financing non-productive investments in developing countries. In chapter 2, entitled "Financial development and poverty reduction in developing countries," the objective is to analyze the relationship between financial development and poverty reduction and the extent to which banks and microfinance reduce poverty. We use Geweke (1982) linear feedback method and measure the extent to which banks and microfinance contribute to poverty alleviation. With data on 71 developing countries over the period 2002-2011, we find in most cases that microfinance reduces poverty more than banks, but requires some income level to expand its activities. However, we do not find strong evidence that the whole financial system reduces poverty more than the individual financial institutions. While our first result suggests that microfinance does not service the very poor, our second result suggests that that individual institutions are in most cases more beneficial than the whole financial system. The third chapter, entitled "Financial development and capital structure of firms," discusses another aspect of financial development usually found in the finance literature. This chapter examines the relationship between financial development and capital structure and analyzes how capital structure might change due to the global financial crisis. We use aggregate data, computed from 5,000 publicly traded firms from 1990 to 2012. The results indicate with the instrumental variable-generalized method of moments methodology that financial development, measured by bank finance and equity finance, has positive effects on capital structure. However, the analysis with respect to the debt maturity indicates that these effects vary with the maturity and the type of finance. While the results are similar in developed countries except in the short-run, in developing countries, only bank finance has significant effects. Our results seem to be consistent with the pecking order theory and suggest that firms in developed countries prefer debt to equity despite the expansion of the equity market, whereas firms in developing countries rely on bank finance. Further, the results show that the subprime crisis has changed firms' capital structure. In developed countries, the crisis has reduced short-term and total debt, whereas in developing countries, it affects more long-term debt. This latter result suggests that developing countries are more resilient to the crisis.