Why Has the Financial Sector Grown so Much? The Role of Corporate Finance.
Thomas Philippon New York University, NBER and CEPR
July 2008 1
Equilibrium Size of Financial Sector
0
.02
ncome Sh hare In .04 .06
.08 8
Economic Share of Finance Industry
1860
1880
1900
1920 1940 year
1960
1980
2000
Within finance • Subsectors — Shares of GDP (fig 2) — Value added vs. assets under management (fig 3)
2
Equilibrium Size of Financial Sector
Figure 2: GDP Shares of Finance Industries
Credit Inter.
Insur.
Trusts & Funds
Priv. Eq & Inv Bk
0.045 0.04 0.035 0.03 0.025 0.02 0.015 0.01 0.005
Source: U.S. Annual Industry Accounts, Bureau of Economic Analysis
20 05
20 03
20 01
19 99
19 97
19 95
19 93
19 91
19 89
19 87
19 85
19 83
19 81
19 79
19 77
0
Within finance • Subsectors — Shares of GDP (fig 2) — Value added vs. assets under management (fig 3) • Functional analysis: — A trader is a trader — tasks performed vs. industry classification (fig4)
3
Equilibrium Size of Financial Sector
Finance Activity related to Corporate Finance.
0.9 0.8 0.7 0.6 05 0.5
BASELINE
0.4
BASE-ADMIN
0.3 02 0.2 0.1 0
Within finance • Subsectors — Shares of GDP (fig 2) — Value added vs. assets under management (fig 3) • Functional analysis: — A trader is a trader — tasks performed vs. industry classification (fig4) • Bottom line: importance of corporate finance and credit intermediation
4
Equilibrium Size of Financial Sector
Potential explanations • Globalization — Financial globalization starts later — Not highly correlated over long period — U.S. financial sector is not a large exporter (unlike UK) • Finance is special ...empirically — Different from rest of service industry (see health care in Table 1) • Finance is special...theoretically — Elasticity of substitution not applicable — Growth. Neither in theory nor in practice
5
Equilibrium Size of Financial Sector
Taking stock • Importance of Finance in the economy varies a lot — Why? Types of growth? • Look for an explanation inside the domestic corporate non financial sector — Fundamental determinants of finance share of income? • Need a model to organize the data — Explicit role for financial intetmediation — Career choice & general equilibrium
6
Equilibrium Size of Financial Sector
Technology and Preferences • Overlapping generations of risk neutral agents ⎡
⎤
i Ct+1 i i ⎦ Ut = Et ⎣Ct +
1+ρ
• Agent chooses a career in the first period of her life — Each cohort of size 1 • Two sectors — Industrial sector: nt — Financial sector: 1 − nt
7
Equilibrium Size of Financial Sector
existing capital: kt
nt generation born at t 1-nt
existing capital: kt current output: F(αnt, kt) i di prod. indiv. d αi
nt generation born at t 1-nt
existing capital: kt
new capital kt+11
current output: F(αnt, kt) i di prod. indiv. d αi fraction π gets idea • rich enough
nt generation born at t 1-nt
new projects productivity θ
existing capital: kt
new capital kt+11
current output: F(αnt, kt) i di prod. indiv. d αi fraction π gets idea • rich enough • too poor
nt
Simple MH and monitoring
generation born at t 1-nt
financial sector productivity μ
new projects productivity θ
Savings existing capital: kt
new capital kt+11
current output: F(αnt, kt) i di prod. indiv. d αi fraction π gets idea • rich enough • too poor
nt generation born at t 1-nt
financial sector productivity μ
new projects productivity θ
existing capital: kt
Demand for fin. services
new capital kt+11
current output: F(αnt, kt) i di prod. indiv. d αi fraction π gets idea • rich enough • too poor
nt generation born at t
jjoint i t dist. di t innovative ideas & current income 1-nt
financial sector productivity μ
new projects productivity θ
existing capital: kt
Supply of fin. services
new capital kt+11
current output: F(αnt, kt) i di prod. indiv. d αi fraction π gets idea • rich enough • too poor
nt generation born at t 1-nt
financial sector productivity μ
new projects productivity θ but et< πnt
Equilibrium wihtout Financial Intermediation
8
Equilibrium Size of Financial Sector
Equilibrium without Moral Hazard New projects Savings
Investment
r
Equilibrium with Moral Hazard New projects Savings
Investment
r
Equilibrium Financial Intermediation • Career Choice
³
´
μφ = α ¯ + π 1 − F θ (αh) v + π • Monitoring Market Clearing μ (1 − n) = πn
9
Z α h αl
Z α h αl
(v − φm (α)) dF θ (α)
m (α) dF θ (α)
Equilibrium Size of Financial Sector
Figure 9: Equilibrium With Monitoring
Density function fθ(α) Invest
Constrained 0
αl
αh
1 α
Monitored Finance
Direct Finance
Self-Finance Self Finance
Theoretical Comparative Statics Proposition. • The income share of the financial sector is constant on the balanced growth path. • For a given interest rate, the income share of finance is independent of the growth rate of the economy. • The size of the financial sector goes to zero when its efficiency becomes either very small or very large. • Efficiency gains in finance reduce rationing and increase investment, but have an ambiguous effect on the GDP share of the finance industry.
10
Equilibrium Size of Financial Sector
Estimation of model parameters • Moments — Investment share of low cash firms: F θ (0.33) − F θ (αl ) s= 1 − F θ (αl ) — Investment share of GDP — Corporate CMI over GDP — Corporate finance share of GDP
11
Equilibrium Size of Financial Sector
Table 1: Data
Period
Finance Share of Compensation
Investment Share of Firms with Income
