INTERNATIONA CAPITAL MARKETS AND INNOVATION FINANCING

Anthony BartzokasProfessorial Fellow

UNU-MERIT

Bartzokas@merit.unu.edu

Second DEIP lectureAmman, 10 June 2008

Part I: an empirical “narrative”

Facts on financial markets, capital flows and technological investment constraints

Current Account Balance in the Main Regions of the World

Sources and uses of World Saving : Financial Balances (saving less investment)

Eastern Europe and ex Soviet Union Countries

The resource gap in Least Developed Countries

Increasing volatility in international capital markets

Estimates of the cost of exogenous financial shocks

Long-term implications of market integration: the cost of self-insurance in the world economy

Fore ign reserves (excluding gold) in m onths of im po rtsindus tr ial and non-oil deve loping countr ies

0

1

2

3

4

5

6

7

8

9

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Industrial Countries

Developing Countries (excl. oil-exportingcountries)

Top 15 holders of reserve assets

A partial explanation : diverse local financial structures in Global financial

markets

Constraints Most Frequently Cited by Firms

Access to finance: a major structural constraint in Developing Countries

Thus – location matters

Sources of fixed investment financing differ for sm all and large firms

Time Line

1994 - July to Nov

1995 - Febr to July

1995 - Aug to Dec

1995/6 - Dec to May

1996 - May

1996 - June

1997 - May

1997/8 - Dec to May

Price/ Share

$.001

$.1717

$.1287-.3333

$.3333

$.3333

$2.3417

$18

$52.11

Sources of Funds

Founder: Jeff Bezos starts Amazon.Com with $10,000, borrows $44,000.

Family: Founder’s father and mother invest $245,500.

Business Angels: 2 angels invest$54,408.

Business Angels: 20 angels invest$937,000

Family: Founder’s siblings invest$20,000.

Venture Capitalists: 2 venture capitalfunds invest $8 million.

IPO: 3 million shares issued raising$49.1 million

Bond issue: $326 million bond issue.

Starting from scratch: financing Amazon.com (1994 - 1999)

Source: Smith and Kiholm (2000)

Back to the country level: raising capital in the global market, the case of Israel

And financial markets and technological restructuring in Europe: the Finish case

Capital raised through equity issues, bond issues, and syndicated bank borrowing by firms in selected midd le-

income countries, 1998–2006

Part II: an analytical “narrative”

Capital markets and innovation financing

Asymmetric Information and Innovation FinancingIncentive problems and their effect on financing po ssibilities…• Sources of Financing:

– Internal (retained earnings, for example)– External:

• debt (obligations to pay specific amounts or the firm is forced into bankruptcy)• Equity (equity holders are entitled to the value of the firm once debt obligations

have been repaid. They are "residual claimants" of the firm.)

Observation: financing for new innovation often is difficult to find…at any price.• Why is there a failure in the market to finance new innovations?

Answer: Asymmetric informationNote: The innovator is the agent of the financier (innovator's effort and the inherent value of the

project determine the financier's payoff).– The innovator may know more about the value of the project than the financier…– Lack of expertise in technical or market area– Difficulty in articulating the value of the innovation.– Hesitancy in revealing information about innovation to third parties for fear of losing

secrecy.– Opportunistic behaviour to hide "bad news"– The innovator may know more about his/her own effort contributed to the project…– Cost of monitoring– Inability to interpret what has been observed.– Opportunistic behaviour to hide effort.

Hence, this agency relationship is subject to asymmetric information on both the value of the innovation and the actions of the innovator. Let's look at an example of the problems that this causes for financing…

INVESTMENT AND TECHNOLOGICAL CHANGE

� Cost of new investment � Adjustment costs (complementary investment and learning)� Working capital

Investment Capabilities: Knowledge gaps

�Capital Structure

�Industrial Organisation

�Corporate Performance

Financial Resources: Constraint markets

•Information asymmetries•Financial Structure•Corporate finance•Incentives structure

•Technological Capabilities•Corporate strategy•Sectoral characteristics

National Innovation Systems and the Business Environment: Selected Variables

Market failures holding back technological investment in Developing Countries

• Imperfections:– credit markets

– equity markets, and – insurance markets

• Coordination failures

• Externalities

Policy Responses• Coordinating technology acquisition decisions acros s firms and sectors • Sharing risk and enabling the financing of investme nt in new technologies and

sectors • Sharing risks in labour training and learning proces ses • Providing targeted infrastructure to critical secto rs • Developing regulatory capacity to maintain and enha nce competitiveness

The mix of policies will depend on the technologies being adopted and the pre-existing strengths and weaknesses of entrepreneurs, financial institutions, infrastructure and skills in the sector.

The critical determinant of success is likely to be governance and regulatory capacities to maintain and enhance competitiveness through monitoring and taking tough action when required, including the early withdrawal of support if progress is unsatisfactory.

While most countries have tried variants of industrial and technology policies in the past, the main cause of their differential success has often been the efficacy with which incentives have been implemented, and the credibility with which their withdrawal has been organized in cases of poorperformance.

INSIGHTS from SECTORAL BENCHMARKING

A guide for future action 1…

A guide for future action- 2: corporate resources and the knowledge economy

RESOURCE CHARACTERISTICS INDICATORS

Financial Borrowing capacity Debt/ Equity ratioInternal funds/ generation Credit rating

Tangible Net cash flowResources Physical Plant and equipment: Market value o f

size, location, technology fixed assets.flexibility. Scale of plantsLand and buildings. Alternatives for fixedRaw materials. assets

Technology Patents, copyrights, know how No. of paten ts owned.R&D facilities. Royalty income

Intangible Technical and scientific R&D expenditure.Resources employees R&D staff

Reputation Brands. Customer loyalty. Company Brand eq uity. Productreputation (with suppliers, customers, price premium .government) Recognition.

Human Training, experience, adaptability, Employee qu alifications,Resources commitment and loyability of customers pay r ates, turnover.

A guide for future action- 3: Corporate expansion and investment financing: a taxonomy

STAGES OF BUSINESS DEVELOPMENT

START-UP FIRMS GROWTH FIRMS MATURE FIRMS

No demonstrated track record; Minimal business system development.

Demonstrated product potential on small scale or prototype basis; Proven management team; Rapid business system development.

Stabilisation of competition; Development of sophisticated business systems; Increasing concentration on cost economies.

STAGES OF FINANCE

EARLY-STAGE FINANCING

LATER-STAGE FINANCING

MATURE AND LATE-STAGE FINANCING

Seed finance- A relatively small amount of capital provided to an inventor or entrepreneur to develop and/or improve a concept.

Second-stage finance- Working capital provided for the initial expansion of a company.

Turn-around finance- Financing provided for companies in trouble for bankruptcy or reorganisation purposes.

Start-up finance- Financing provided to companies for product development and marketing.

Third-stage finance- Financing provided for major expansion of a company whose sales volume is increasing.

Management/lever-aged buy-out- Financing provided for management to acquire equity interest in firm.

First-stage finance- Financing provided to companies to initiate commercial manufacturing and sales.

Bridge finance- Financing provided for a company expecting to go public within six months to a year.

Mergers/acquisition privatisation- Financing provided to cover firm’s share of costs in a merger, acquisition or privatisation of company.

Policy responses to private under-investment in

innovation, phase I

Policy responses to private under-investment in innovation-II

Non-financial measures

Readings…