INTERNATIONA CAPITAL MARKETS AND INNOVATION FINANCING

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1 INTERNATIONA CAPITAL MARKETS AND INNOVATION FINANCING Anthony Bartzokas Professorial Fellow UNU-MERIT Second DEIP lecture Amman, 10 June 2008

2 Part I: an empirical narrative Facts on financial markets, capital flows and technological investment constraints

3 Current Account Balance in the Main Regions of the World

4 Sources and uses of World Saving: Financial Balances (saving less investment) Eastern Europe and ex Soviet Union Countries

5 The resource gap in Least Developed Countries

6 Increasing volatility in international capital markets

7 Estimates of the cost of exogenous financial shocks

8 Long-term implications of market integration: the cost of self-insurance in the world economy 9 Industrial Countries Foreign reserves (excluding gold) in m onths of im ports industrial and non-oil developing countries 8 7 Developing Countries (excl. oil-exporting countries)

9 Top 15 holders of reserve assets

10 A partial explanation: diverse local financial structures in Global financial markets

11 Constraints Most Frequently Cited by Firms

12 Access to finance: a major structural constraint in Developing Countries

13 Thus location matters

14 Sources of fixed investment financing differ for small and large firms

15 Starting from scratch: financing Amazon.com ( ) Time Line Price/ Share Sources of Funds July to Nov Febr to July Aug to Dec 1995/6 - Dec to May May June May 1997/8 - Dec to May $.001 $.1717 $ $.3333 $.3333 $ $18 $52.11 Founder: Jeff Bezos starts Amazon. Com with $10,000, borrows $44,000. Family: Founder s father and mother invest $245,500. Business Angels: 2 angels invest $54,408. Business Angels: 20 angels invest $937,000 Family: Founder s siblings invest $20,000. Venture Capitalists: 2 venture capital funds invest $8 million. IPO: 3 million shares issued raising $49.1 million Bond issue: $326 million bond issue. Source: Smith and Kiholm (2000)

16 Back to the country level: raising capital in the global market, the case of Israel

17 And financial markets and technological restructuring in Europe: the Finish case

18 Capital raised through equity issues, bond issues, and syndicated bank borrowing by firms in selected middleincome countries,

20 Part II: an analytical narrative Capital markets and innovation financing

21 Asymmetric Information and Innovation Financing Incentive problems and their effect on financing possibilities Sources of Financing: Internal (retained earnings, for example) External: debt (obligations to pay specific amounts or the firm is forced into bankruptcy) Equity (equity holders are entitled to the value of the firm once debt obligations have been repaid. They are "residual claimants" of the firm.) Observation: financing for new innovation often is difficult to find at any price. Why is there a failure in the market to finance new innovations? Answer: Asymmetric information Note: The innovator is the agent of the financier (innovator's effort and the inherent value of the project determine the financier's payoff). The innovator may know more about the value of the project than the financier Lack of expertise in technical or market area Difficulty in articulating the value of the innovation. Hesitancy in revealing information about innovation to third parties for fear of losing secrecy. Opportunistic behaviour to hide "bad news" The innovator may know more about his/her own effort contributed to the project Cost of monitoring Inability to interpret what has been observed. Opportunistic behaviour to hide effort. Hence, this agency relationship is subject to asymmetric information on both the value of the innovation and the actions of the innovator. Let's look at an example of the problems that this causes for financing

22 INVESTMENT AND TECHNOLOGICAL CHANGE Cost of new investment Adjustment costs (complementary investment and learning) Working capital Financial Resources: Constraint markets Investment Capabilities: Knowledge gaps Information asymmetries Financial Structure Corporate finance Incentives structure Technological Capabilities Corporate strategy Sectoral characteristics Capital Structure Industrial Organisation Corporate Performance

24 National Innovation Systems and the Business Environment: Selected Variables

25 Market failures holding back technological investment in Developing Countries Imperfections: credit markets equity markets, and insurance markets Coordination failures Externalities

26 Policy Responses Coordinating technology acquisition decisions across firms and sectors Sharing risk and enabling the financing of investment in new technologies and sectors Sharing risks in labour training and learning processes Providing targeted infrastructure to critical sectors Developing regulatory capacity to maintain and enhance competitiveness The mix of policies will depend on the technologies being adopted and the pre-existing strengths and weaknesses of entrepreneurs, financial institutions, infrastructure and skills in the sector. The critical determinant of success is likely to be governance and regulatory capacities to maintain and enhance competitiveness through monitoring and taking tough action when required, including the early withdrawal of support if progress is unsatisfactory. While most countries have tried variants of industrial and technology policies in the past, the main cause of their differential success has often been the efficacy with which incentives have been implemented, and the credibility with which their withdrawal has been organized in cases of poor performance.

27 INSIGHTS from SECTORAL BENCHMARKING

28 A guide for future action 1

29 A guide for future action- 2: corporate resources and the knowledge economy RESOURCE CHARACTERISTICS INDICATORS Financial Borrowing capacity Debt/ Equity ratio Internal funds/ generation Credit rating Tangible Net cash flow Resources Physical Plant and equipment: Market value of size, location, technology fixed assets. flexibility. Scale of plants Land and buildings. Alternatives for fixed Raw materials. assets Technology Patents, copyrights, know how No. of patents owned. R&D facilities. Royalty income Intangible Technical and scientific R&D expenditure. Resources employees R&D staff Reputation Brands. Customer loyalty. Company Brand equity. Product reputation (with suppliers, customers, price premium. government) Recognition. Human Training, experience, adaptability, Employee qualifications, Resources commitment and loyability of customers pay rates, turnover.

30 A guide for future action- 3: Corporate expansion and investment financing: a taxonomy STAGES OF BUSINESS DEVELOPMENT START-UP FIRMS GROWTH FIRMS MATURE FIRMS No demonstrated track record; Minimal business system development. Demonstrated product potential on small scale or prototype basis; Proven management team; Rapid business system development. Stabilisation of competition; Development of sophisticated business systems; Increasing concentration on cost economies. STAGES OF FINANCE EARLY-STAGE FINANCING LATER-STAGE FINANCING MATURE AND LATE- STAGE FINANCING Seed finance- A relatively small amount of capital provided to an inventor or entrepreneur to develop and/or improve a concept. Second-stage finance- Working capital provided for the initial expansion of a company. Turn-around finance- Financing provided for companies in trouble for bankruptcy or reorganisation purposes. Start-up finance- Financing provided to companies for product development and marketing. Third-stage finance- Financing provided for major expansion of a company whose sales volume is increasing. Management/lever-aged buy- out- Financing provided for management to acquire equity interest in firm. First-stage finance- Financing provided to companies to initiate commercial manufacturing and sales. Bridge finance- Financing provided for a company expecting to go public within six months to a year. Mergers/acquisition privatisation- Financing provided to cover firm s share of costs in a merger, acquisition or privatisation of company.

31 Policy responses to private under-investment in innovation, phase I

32 Policy responses to private under-investment in innovation-ii Nonfinancial measures

33 Readings

CHAPTER 3 INVESTMENT STRATEGY AND VENTURE CAPITAL

CHAPTER 3 INVESTMENT STRATEGY AND VENTURE CAPITAL This chapter provides a basic explanation of what is an investment strategy as well as a comprehensive background of the concept of venture capital and