Equity Markets and Economic Development: What Do We Know

As shown in Figure 1, the highest of the curves is the locus corresponding toα = 1 , and the
lowest is the locus corresponding toα= 0 . Inspection of the figure shows that the proportions
of firms which prefer one contract to the other change with the level of information
transparency. The fact that the proportion of firms preferring equity to debt is more important
for high levels of information asymetries is due to the construction of the asymetry
variable Z_t . More interestingly, the figure shows that the number of equity contracts increases
with informational transparency, as we move from Z₀ to Z₁ . This model thus highlights that
informational dynamics play a central role in determining the contribution of equity markets
to the financing of investment project. This also suggests that equity markets can be useful,
but constitute be poor guides to investors in the presence of information asymmetries.

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