INTERNATIONAL FINANCE CORPORATION RESEARCH SERIES FINANCING FIRM GROWTH The Role of Capital Marketsin Low- and Middle-Income Countries OVERVIEW Edited by Cesaire A. Meh Sergio L. Schmukler Financing Firm Growth This book, along with any associated content or subsequent updates, can be accessed at https://hdl.handle.net/10986/42755. Scan the QR code to see all titles in this series. International Finance Corporation Research Series The International Finance Corporation (IFC) Research Series explores the mobilization of private sector capital in support of development and the elimination of poverty in a livable world. Publications are subject to review meetings chaired by the IFC managing director and the vice president of economics. Relevant regional or industry vice presidents and directors also participate. The peer reviewers include experts from outside the World Bank Group. Books in the series Financing Firm Growth: The Role of Capital Markets in Low- and Middle-Income Countries, Cesaire A. Meh and Sergio L. Schmukler, editors, 2025 Digital Opportunities in African Businesses, Marcio Cruz, editor, 2024 All books in the International Finance Corporation Research Series are available for free at https://hdl.handle.net/10986/41286. INTERNATIONAL FINANCE CORPORATION RESEARCH SERIES OVERVIEW Financing Firm Growth The Role of Capital Markets in Low- and Middle-Income Countries Edited by Cesaire A. Meh and Sergio L. Schmukler This booklet contains the overview from Financing Firm Growth: The Role of Capital Markets in Low- and Middle-Income Countries, doi: 10.1596/978-1-4648-2191-2. A PDF of the final book is available at https:// openknowledge.worldbank.org/ and http://documents.worldbank.org/, and print copies can be ordered at www.amazon.com. 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CONTENTS Foreword ix Acknowledgments xi Overview 1 Capital Markets Have Been Financing Firms Around the Globe 1 Debt and Equity Issuances Have Surged in Low- and Middle-Income Countries 2 How Capital Markets Can Boost Investment, Employment, and Output 4 Economic Growth and Policy Reforms Can Drive Capital Market Expansion 6 What Are the Key Takeaways? 8 Notes 8 Box O.1 Using the Capital Markets Portal 1 Figures O.1 Firms Significantly Expanded Their Capital Market Financing in Low- and Middle-Income Countries 2 O.2 The Expansion of Capital Market Financing Was Associated with a Growing Number of New Issuers in Low- and Middle-Income Countries 3 O.3 Firms in Low- and Middle-Income Countries Exhibited Strong Growth in Physical Capital after Capital Market Issuance 5 O.4 Countries with Pension Reforms Experienced Higher CNI in Domestic Markets 7 vii FOREWORD Capital markets can have a transformative impact on firms and economies. They are an increasingly important source of firm financing, particularly for innovative, long-term, and capital-intensive projects. By enabling efficient allocation of funds toward productive firms, capital markets foster private sector growth, which, in turn, boosts employment and productivity across the broader economy. Yet capital markets in low- and middle-income countries still lag behind those in advanced economies. This persists even as financing needs by firms in these markets intensify, driven by rapid technological advancements, tighter financing conditions, and the reshaping of global supply chains. This research presents new data and analysis on how firms in emerging and developing economies have accessed debt and equity capital markets over the past 30 years. It provides granular evidence on which firms participate as capital markets grow, the implications for firm growth, and the broader economic effects on productivity. By examining over 20,000 firms across 106 low- and middle- income countries and economies, this book offers novel insights on capital market financing for firms. It also presents measures to promote such financing. We find encouraging evidence that there has been progress in recent decades, with more and smaller firms from a growing number of low- and middle-income countries tapping into capital markets. However, more needs to be done to address the remaining gaps. Capital markets are important to private sector growth and are therefore central to our work. The World Bank Group/IFC has long been a leader in promoting capital market development in emerging markets by being an anchor investor in new issuances, and through research, capacity-building, and strategic injections of capital. Over decades of work, including pioneering new types of data collection on emerging stock markets and supporting local-currency transactions, we have helped to advance these markets. ix x FINANCING FIRM GROWTH I am confident that the insights presented in this book will further efforts to support investors. Such information is critical for investors for whom emerging markets may otherwise appear opaque and risky. The accompanying Capital Markets portal is a step toward enhancing transparency on key firm characteristics. I hope all stakeholders—both public and private—interested in capital markets in low- and middle-income countries will find this book and the portal to be invaluable resources for deepening their understanding and shaping the future of these markets. Makhtar Diop Managing Director International Finance Corporation ACKNOWLEDGMENTS This book was prepared under the guidance of Susan Lund, Vice President for Economics and Private Sector Development, International Finance Corporation (IFC), and Paolo Mauro, Director of IFC’s Economics and Market Research Department. In addition, Indermit Gill, Senior Vice President for Development Economics (DEC) and World Bank Group Chief Economist; Roumeen Islam, Senior Economic Adviser to the IFC Managing Director; and Denis Medvedev, Senior Economic Adviser, provided support and guidance. The book was written jointly by an IFC and DEC team, led by Cesaire A. Meh, Manager, and Sergio L. Schmukler, Research Manager, with significant contributions from Imtiaz Ul Haq. The core team comprised Manuel García- Santana, Pablo Hernando-Kaminsky, Alvaro Pedraza, and Imtiaz Ul Haq. Matias Moretti contributed to an early draft of the book. Furthermore, Brian Castro Aguirre, Juliana Beall, Dmitri Kirpichev Cherezov, Miquel Lorente, Paolo Sabella, and Matias Gonzalo Soria provided excellent support on data used in the analysis. We are also grateful to Nicolas Cogorno for developing the accompanying online Capital Markets Portal. The team benefited from numerous interactions with researchers from academia and international policy institutions. Natalie Bau from the University of California at Los Angeles (UCLA), Stijn Claessens from Yale University, Julian Di Giovanni from the Federal Reserve Bank of New York, Deniz Igan from the Bank for International Settlements, and Augusto de la Torre from Columbia University peer reviewed the book. Peer reviewers from IFC included Alfonso Garcia Mora, with additional comments from Jeff Anderson, John Gandolfo, Mohamed Gouled, Roumeen Islam, Morgan Landy, and Tomasz Telma. Dilek Aykut, Marcio Cruz, Kianna Freeman, Jacqueline T. Irving, Maty Konte, Ralf Martin, Florian Moelders, Mariana Pereira- Lopez, Zeinab Partow, Rey Zhangrui Wang, Verena Wiedemann, and Nadege Yameogo contributed with additional discussions. xi xii FINANCING FIRM GROWTH Peer reviewers from the World Bank included Ana Paula Cusolito, Erik Feyen, and Jean Pesme, with additional comments from Deon Filmer, Indermit Gill, and Norman Loayza. Juan Jose Cortina, Robert Cull, Tatiana Didier, and Ana Fiorella Carvajal provided valuable feedback. The book also benefited from discussions with participants in the IFC and Jeune Afrique’s third annual Africa Financial Industry Summit, hosted in Morocco, as well as during presentations at Columbia University, the 27th Congreso de Tesorería, Asobancaria, Colombia, the International Christian University in Tokyo, and the Southern Economic Association. We thank Erik Churchill, David Harrison, and Chris Vellacott from IFC’s publications team for their editorial contributions, as well as Irina Sarchenko for significant help with graphic design. Bruce Ross-Larson led the editorial process of the earlier version of the book. We are also grateful to the World Bank Group’s editorial production team, including Jewel McFadden, acquisitions editor; Mary Fisk, production editor; and Melina Rose Yingling, designer, for the marketing, production, and design of this book, and to the IFC communications team, including Erik Churchill and Monica De Leon, for their creative energy in promoting the book. We also thank Adama Badji, Gleice De Marrocos, Sabrina Islam, Linette Malago, Irina Tolstaia, Carmen Andira Watson, and Fatima Yousofi for their exceptional administrative support. This book is a product of IFC’s Economics and Private Sector Development Vice Presidency and DEC. The team wishes to express its appreciation to the Joint Capital Markets Program (J-CAP), and in this case to the Ministry of Finance of Luxembourg, which financially supported this study under J-CAP. OVERVIEW Capital Markets Have Been Financing Firms Around the Globe Over the past three decades, capital market financing has surged for firms in low- and middle-income countries.1 This growth is not confined to a few established corporates but includes a broad spectrum of firms from an increasing number of countries. Firms are deploying this capital to become more productive—investing in physical assets, hiring more workers, and expanding operations, spurring growth both at the firm level and within their economies. This book analyzes data from nearly 80,000 firms worldwide, focusing on how the 20,000 firms located in 106 low- and middle-income countries access and use capital market financing. Leveraging a novel database of global bond and equity issuances between 1990 and 2022, the findings reveal that the expansion of capital market financing has facilitated access for smaller, younger, and more productive firms than those already participating (box O.1 introduces a tool for analyzing the data). These firms have subsequently experienced significant growth in physical capital, employment, and sales. The book explores potential drivers behind the capital market expansion, focusing on the role of economic growth and supportive policies. BOX O.1 Using the Capital Markets Portal While focusing on low- and middle-income countries, the book analyzes many patterns of capital market financing of firms for all countries in the world. For readers interested in alternative comparisons, the companion Capital Markets Portal, https:// capitalmarketsportal.worldbank.org, is an online tool that allows users to reproduce figures and tables from the book for any country and region of their choice and to compare them across desired benchmarks. 1 2 FINANCING FIRM GROWTH Debt and Equity Issuances Have Surged in Low- and Middle-Income Countries To measure the expansion of capital markets, this book focuses on cumulative net capital issuance (CNI)—the sum of equity issuances and bond issuances since the beginning of the period minus bonds that have matured. The book examines the 1990–2022 period to uncover long-run trends in capital market activity. The analysis focuses only on firms participating in capital markets. Although these firms are a small fraction of the total number of firms, they typically account for a large share of national income as they tend to be large firms. Firms from low- and middle-income countries raised CNI of US$4 trillion from bond and equity markets between 1990 and 2022, much of it coming after the turn of the millennium (figure O.1).2 From 2000 to 2022, CNI increased fourfold in middle- income countries and eightfold in low-income countries. The CNI in these two groups of countries doubled as a share of gross domestic product (GDP) in the same period. FIGURE O.1 Firms Significantly Expanded Their Capital Market Financing in Low- and Middle-Income Countries US$, billions 4,000 3,000 2,000 1,000 0 1990 2000 2010 2020 Middle-income countries Low-income countries Source: Calculations using issuance data from the Securities Data Company Platinum database from LSEG. Note: This figure shows the CNI of nonfinancial firms for the 1990–2022 period in billions of 2020 dollars for low- and middle-income countries. CNI each year is calculated as the sum of equity issuances and bond issuances since 1990, minus bonds that have matured since 1990 for each country group. Appendix B provides the list of countries, grouped by income category, following the World Bank classification for the year 1990. CNI = cumulative net capital issuance. OVERVIEW 3 Capital market financing in low- and middle-income countries has grown faster than bank financing since the early 1990s. Although banks remain the primary providers of external finance for most firms, capital markets are becoming an important alternative for a growing number of companies. Even firms that rely on banks or other sources for their financing can benefit from the rise in capital markets. Capital market growth can unlock financing for small firms by freeing up bank credit or enhancing access through linkages with issuing companies. Capital markets also facilitate private equity investments by providing exit opportunities via initial public offerings. The expansion of capital markets attracted a significant influx of new firms, which captured a large share of the funds raised in these markets (figure O.2). From 2000 to their peak in 2021, the number of nonfinancial firms issuing bonds or equities annually increased 300 percent in low- and middle-income countries versus 40 percent in high-income countries. Around 14,000 firms became new participants in capital markets in low- and middle-income countries between 2000 and 2022. Moreover, firms from 32 middle-income countries and 13 low-income countries accessed capital markets for the first time during this period. FIGURE O.2 The Expansion of Capital Market Financing Was Associated with a Growing Number of New Issuers in Low- and Middle-Income Countries Number of new issuers each year 1,000 800 Middle-income 600 400 Low-income 200 0 0 2 4 6 8 10 12 14 16 18 20 22 0 0 0 0 0 20 20 20 20 20 20 20 20 20 20 20 20 Source: Calculations using issuance data from the Securities Data Company Platinum database from LSEG. Note: This figure shows the number of firms entering capital markets from 2000 to 2022 for low- and middle-income countries. Each year, only firms that issued for the first time are counted. Appendix B provides the list of countries, grouped by income category, following the World Bank classification for the year 1990. 4 FINANCING FIRM GROWTH Domestic bond and equity markets, primarily in local currencies, have been the driving force behind this growth in low- and middle-income countries. Between 1990 and 2022, domestic markets accounted for more than half of total issuance (53 percent for bonds and 79 percent for equities). Moreover, the average size of individual domestic bond issuances decreased by approximately 30 percent between 2000–09 and 2010–22 for firms raising funds in capital markets for the first time. Since small firms typically issue smaller amounts, the decline in average size of domestic bond issuances suggests that access to domestic capital markets has become easier for them. In contrast, the size of bond issuances in international markets increased during the same period, indicating that larger firms were tapping into international capital markets. As capital markets expanded, a broader range of firms gained access to financing, with a greater share of funds allocated to smaller, younger, more productive, and financially more constrained firms than those already participating in capital markets. New participants—firms that accessed capital markets only from 2000 onward—accounted for more than 60 percent of CNI in low- and middle-income countries by 2022. By contrast, new participants accounted for 42 percent of CNI in high-income countries. Compared to firms that accessed capital markets in the 1990s, these new participants were younger and smaller in relation to sales, physical capital, and employment. At the time of issuance, new participants in low- and middle-income countries had higher marginal returns to capital (defined as the additional output a company generates from using an extra unit of capital) than firms in the same industry and country that were active in capital markets in the 1990s. For this reason, investing in these firms had the potential to yield a greater increase in production or profits, making them particularly effective recipients of new capital. How Capital Markets Can Boost Investment, Employment, and Output The impact of capital market participation on firms and the broader economy hinges on whether firms use the funds raised for productive activities. This book presents new evidence that firms used the proceeds to invest in productive assets. In the first year after raising capital, these firms’ investment in physical capital rose 16 percent in low-income countries and 8 percent in middle-income countries, with some of these effects persisting for years (figure O.3). This increase in physical capital was associated with an increase in both employment and sales. OVERVIEW 5 FIGURE O.3 Firms in Low- and Middle-Income Countries Exhibited Strong Growth in Physical Capital after Capital Market Issuance Cumulative change from year before issuance (%) 30 20 16.4 10 7.6 Low-income 0 Middle-income e ce er r r r r te te te te or ft an af af af af ef ra su rb s s s s ea ar ar ar ar Is ea ye ye ye ye 1y 1y 2 3 4 5 Sources: Calculations using issuance data from the Securities Data Company Platinum database and firms balance sheet data from Worldscope, both from LSEG. Note: This figure shows the estimated cumulative impact of a firm’s issuing activity on its physical capital in low-income countries and middle-income countries. The baseline for estimating cumulative impact is the year before issuance. Appendix B provides the list of countries, grouped by income category. The effects of capital market issuances on firm growth vary depending on the issuer and the financial instruments used. The impact on growth is particularly strong for new participants, despite their smaller issuances, as it appears to alleviate their financial constraints. The estimates suggest that first-time issuances offer greater relief from financial constraints than subsequent ones. The positive effects on firm growth are twice as strong for equity issuances as for all bond issuances (including refinancing)—perhaps reflecting the greater flexibility that equity financing provides without the pressure of regular, fixed debt payments. For instance, equity issuances are associated with a 13 percent increase in physical capital, compared with a 5 percent increase in bond issuances. These results are consistent with the idea that firms with high growth potential may prefer to issue equity over bonds. 6 FINANCING FIRM GROWTH At the economywide level, the findings suggest that capital is being allocated more efficiently. Firms’ participation in capital markets is linked to increases in a country’s total stock of physical capital—measured as firms’ property, plant, and equipment—and employment levels. In low-income countries, firm issuance activity accounted for 21 percent of the growth in physical capital and 12 percent of the growth in employment among publicly listed firms between 2000 and 2022. In middle-income countries, these estimates are 22 percent and 20 percent, respectively. Because firms with higher marginal returns to capital raised more funds, capital markets allocated capital more efficiently across firms, resulting in a greater impact on output. New participants in capital markets in the 2000s were especially important drivers of these positive effects. Economic Growth and Policy Reforms Can Drive Capital Market Expansion The expansion of capital market financing in low- and middle-income countries is related to domestic economic growth. Economic growth increases the supply of capital by increasing investable savings for households and boosts demand by expanding business opportunities for firms. The book finds that GDP growth is significantly associated with capital market expansion, accounting for nearly half of the variation in CNI across countries. Policies to increase investable savings, such as moving to a prefunded pension system, can also spur fundraising in capital markets. Moving to a prefunded pension system is associated with stronger growth of domestic capital markets. Mandating retirement contributions by workers in individually funded accounts promotes the growth of private investment and pension funds, giving firms access to a new pool of savings. In low- and middle-income countries that undertook such reforms between 1990 and 2022, domestic CNI (as a share of GDP) increased close to five times in the four years following reform, whereas international issuance did not rise significantly (figure O.4). Reforms liberalizing international financial flows can allow firms to access a broader range of funding sources. For example, Colombia experienced several rounds of financial liberalization over the past three decades, with reforms including easing capital restrictions, simplifying access to investment products by foreign investors, enhancing access to foreign financial services, and offering preferential tax incentives for foreign investors. Low- and middle-income countries undertaking such liberalization reforms experienced a boost in international bond issuances, but not in domestic ones. OVERVIEW 7 FIGURE O.4 Countries with Pension Reforms Experienced Higher CNI in Domestic Markets Change in CNI (% of GDP) 5 Reform Domestic Domestic 4 3 2 1 International International 0 1 2 3 4 Years after reform Sources: Calculations using data from the Securities Data Company Platinum database from LSEG and the International Federation of Pension Fund Administrators and GDP data from the World Bank’s World Development Indicators. Note: The sample includes 30 low- and middle-income countries with pension reforms introducing mandatory or quasi-mandatory individually funded programs between 1990 and 2022 (chapter 5 provides a list of these countries, and appendix O details the methodology used). The figure shows the impact of major pension reforms on domestic and foreign issuance activity, beyond what would be expected in a counterfactual drawing on a control group of 117 countries from various income groups that did not implement major pension reforms during the sample period. The event year is defined as the year when the first major pension reform was implemented in each country. The vertical axis shows the total change in the CNI as a proportion of GDP, relative to the year before the reform. The ratio of CNI to GDP for year Y is computed as the sum of equity issuance, bond issuance (minus bonds that matured), or both between 1990 and year Y, divided by GDP in year Y. In the baseline year (that is, one year before reform) domestic and foreign CNI was 0.7 percent and 1.7 percent of domestic GDP, respectively. Point estimates are presented controlling for year and country fixed effects. CNI = cumulative net capital issuance; GDP = gross domestic product. 8 FINANCING FIRM GROWTH Policies focused on improving financial intermediation can also facilitate the transfer of funds from investors to firms. For instance, developing pricing benchmarks, such as a yield curve through sovereign issuances, can be critical for pricing corporate issuances as countries gain access to capital markets. For this reason, first-time sovereign issuances usually preceded initial corporate issuances in low- and middle-income countries. Strengthening investor protections and improving the domestic information environment can also reduce investors’ expropriation risks and information costs. Stronger regulations on both these fronts are associated with higher domestic CNI (as a share of GDP). Sustained capital market development requires comprehensive domestic reforms that encompass a broad set of policy measures, rather than isolated initiatives. Firms can supplement these measures by undertaking internal measures to reduce risks to investors, such as improving their corporate governance or voluntarily disclosing material information beyond mandated levels. What Are the Key Takeaways? Deeper domestic capital markets can scale up private investment in low- and middle-income countries and channel resources to the most productive firms. The book shows that domestic capital—to an even greater extent than foreign capital—has been a crucial source of private financing. Domestic markets can channel funds in local currencies to firms with high growth opportunities. More generally, developing domestic bond and equity markets can help local investors to fund the expansion of financially constrained firms, with beneficial effects for the economy overall. Notes 1. Low- and middle-income countries are classified based on World Bank income classifications in 1990 (the beginning of the sample period). Appendix B presents the list of countries by income groups. Throughout the book, all references to low- and middle-income countries exclude China, which is treated separately given its economic ascent and size as well as its shift from low-income to middle-income status during the period under consideration. 2. All dollar amounts are inflation-adjusted 2020 US dollars unless otherwise indicated. Well-functioning capital markets can foster economic growth and allocate resources efficiently. Firms can tap into a broader funding base by issuing debt and equity in capital markets, often at cheaper rates and longer tenors than through other sources of external finance, such as banks. However, capital markets in low- and middle-income countries have lagged those in high-income countries. Accordingly, the firms in those countries have more often relied on bank financing or retained earnings to fund investment and expansion, and they have experienced greater financial constraints than their counterparts in high-income countries. Financing Firm Growth: The Role of Capital Markets in Low- and Middle-Income Countries shows that the gap in capital market financing between low- and middle-income countries and high-income countries has narrowed, with resulting benefits for both the firms accessing those markets and for the countries in which they operate. The analysis reveals greater participation by firms from low- and middle-income countries in capital markets since the 2000s. Most of these firms are new participants in capital markets, and they tend to be smaller, younger, and more productive than those already participating. Firms are deploying capital raised in markets to become more productive—investing in physical assets, hiring more workers, and expanding operations, spurring growth both at the firm level and within their economies. To reach these findings, the analysis used a novel database of the universe of bond and equity issuances from companies between 1990 and 2022. The insights leverage data from nearly 80,000 firms worldwide, focusing on how 20,000 firms across 106 low- and middle-income countries access and use capital market financing. Financing Firm Growth is a groundbreaking exploration that delves into the vital role that capital markets play in driving business expansion in low- and middle-income countries. Backed by data from 80,000 firms across 147 economies, the authors explore the factors underlying capital market growth and its benefits for economies and firms at all levels of development. This book is a must-read for investors, policy makers, and economists shaping the future of global finance. — Laura Alfaro, Warren Alpert Professor of Business Administration, Harvard Business School IN PARTNERSHIP WITH SKU 33775