Information, Resource Allocation, and the Development of Financial Markets

Abstract

This paper explores the linkages between the informational efficiency of stock prices, corporate investment and financing decisions, and the development of equity markets in emerging economies. We begin with the premise that investors obtain information costlessly and purely by chance (i.e., "serendipitously"), as well as by expending scarce resources, and show that publicly financed firms generally make better investment decisions than privately financed firms when the influence of serendipitous information on firm values is sufficiently strong. In this case, resources are allocated more efficiently in an economy where most firms are publicly rather than privately financed. However, because of externalities, an inferior equilibrium can exist where most firms remain privately financed.

JEL Classification: G14, G32, G38