Corporate Finance.

• Author: Rajan, Raghuram G.

Raghuram G. Rajan [*]

The NBER's Corporate Finance Program was established in 1991 with Robert W. Vishny as its first director; I became Program Director in 1998. Corporate finance, narrowly interpreted, is the study of the investment and financing policies of corporations. But since firms are at the center of economic activity--and since almost any topic economists are concerned with, from incentives and risksharing to currency crises, affect corporate financing and investment--it is increasingly hard to draw precise boundaries around the field. Reflecting this, Jeremy C. Stein and Luigi G. Zingales organized an NBER/Universities Research Conference in December 1999 on the "Macroeconomic Effects of Corporate Finance." In fact, I think some of the most interesting work in corporate finance is now being done at its interface with other areas. I describe some of that work in this report.

Law and Financial Development

It is fitting to start with Andrei Shleifer's recent path-breaking work on the links between law and finance, since he won the John Bates Clark Medal in 1999. In a series of papers, Rafael La Porta, Florencio Lopez-de-Silanes, Shleifer, and Vishny describe links between the origin of a country's legal system and the extent to which the system protects investors. They find, among other things, that countries with a legal code based on common law protect investors better than countries with a legal code based on civil law. [1]

Legal systems also seem to directly affect the development of external capital markets. It turns out that stock markets and debt markets have developed less in countries with a French civil law origin than in countries with a common law origin. [2] Legal origin also appears to be related to corporate ownership, dividend policies, and valuations, [3] This body of work has inspired a whole new literature on law and finance.

However, while specific laws may plausibly affect the nature of corporate ownership and finance, there is still no theory of why legal origin should affect finance, if in fact it does. Some economists, myself included, believe that other forces correlated with common law origins may be responsible for the relationships that La Porta, Lopez-de-Silanes, Shleifer, and Vishny find in the data. But debates of this kind are what make corporate finance such a fertile area of inquiry today.

Corporate Investment

While there has been much attention paid to corporate financing, we know very little about corporate investment, other than through acquisitions, largely because of the paucity of large sample data. We now have some data on the investment practices of diversified firms, and researchers have begun to test theories of the beneficial effects of these firms, Diversified firms create internal capital markets, which then finance good projects that the market ignores. [4] However, the notion that diversified firms make efficient investments is not consistent with the growing evidence that they trade at a discount relative to focused firms. Recently, researchers have tried to link the discount that diversified firms trade at to distortions in the allocations of capital budgets among divisions. [5] Others have attempted to show that some of the evidence of the diversification discount, or of the misallocation, may be spurious or overstated. [6] Clearly, this debate will go on for some time.

Innovation

There has been increasing interest in the sources of innovation and the financial structures that promote it. Samuel S. Kortum and Josh Lerner [7] ask whether venture capital spurs innovation. In a study of 20 different industries over three decades, they find a positive association between the presence of venture capital and the rate of patenting. Of...