STOGK MARKETS m DEVELOPMENM CASE ; A- ‘ may OF PANAMA . Déssefiaficn far “the Degree of R). D. ‘ MICHIGAN STATE UNIVERSITY MCHCLAS JOHN WA 1974 Date 0-7639 5" . i LIBQARY _ Mkfigaflsw This is to certify that the thesis entitled STOCK MARKETS AND DEVELOPMENT: A CASE STUDY OF PANAMA presented by Nichoias John De Grazia has been accepted towards fulfillment of the requirements for Ph . D o Jegree in Economi CS fibw Major professor flcf, 25/49‘79‘. ABSTRACT STOCK MARKETS AND DEVELOPMENT: A CAST STUDY OF PANAMA By Nicholas John DeGrazia This dissertation tests the hypothesis that Panama should adopt an organized stock market at its present stage of economic development because: (1) there is a need for equity-financed capital on the part of Panamanian business firms; (2) there are many financial institutions willing and able to act as financial intermediaries; (3) there is an ever-increasing supply of savings that can be expected to flow into business firms through the sale of stock; and (4) a stock market will promote economic development by increasing the capacity to produce goods and services. A model is presented which assumes that the demand for and supply of equity-financed capital is dependent upon factors internal and external to the business firm. The external factors that affect both the demand and supply side include the types of existing financial institutions, the structure of existing capital markets and the regulatory framework in Panama. The external factors that affect the sup-ply si return or. there are for equi: primarily firms in internal side is t v. collected Within t'r.F analysis doing bu:- results C SCUI'CES E. of bankirl gOVemin: I EStablis': deVEIOpne SectOr if nQbEr Of 13639 fir Nicholas John DeGrazia supply side include the volume of savings and the rates of return on alternative forms of savings. It is assumed that there are no external factors that only affect the demand for equity-financed capital. The internal factors that primarily affect the demand side are the types of business firms in the economy and their capital needs. The only internal factor that affects both the demand and supply side is the financial position of the business firms. Data on the external and internal factors were collected while the author resided in Panama for seven months within the period l97l-l973. The data include (1) an analysis of the financial statements from 255 companies doing business in Panama between 1969 and 1971; (2) the results of fifty questionnaires used to determine the sources and uses of capital funds; and (3) a discussion of banking laws, tax laws, laws of incorporation and laws governing the sale of securities in Panama. The dissertation concludes that Panama should not establish a stock market at its present stage of economic deve10pment for a number of reasons. First, the business sector in Panama is characterized by a relatively large number of commercial and service-oriented enterprises. These firms need capital funds primarily to finance inven— tories and accounts receivable. Such capital requirements are unpredictable, occur frequently and tend to be better satisfied by a source of short-term capital funds such as an overc‘ were abl chose mo tions it: they are Panama t- business and the conduci‘; the leve 0f bank sources. derived househo; Promote ROt app: 01‘ the C Fronds. a Strong of indue Sented i Panama E; Nicholas John DeGrazia an overdraft mechanism. Although the companies surveyed were able to raise funds through the sale of stock, they chose not to do so. Second, although there are many financial institu- tions in Panama capable of buying corporate securities, they are generally unwilling to do so. Banks operate in Panama because it is relatively profitable to undertake business there. Liberal tax laws, the U.S. dollar standard, and the absence of exchange controls and a central bank are conducive to profitable banking activity. Third, although the level of savings in Panama is growing rapidly in terms of bank deposits, most of the deposits are from foreign sources. The largest proportion of domestic savings is derived from corporations in Panama, not from individual households. Fourth, stock markets cannot be expected to promote economic development in Panama. Such markets may not appreciably affect the problems of poverty, unemployment or the distribution of income in a positive way. Stock markets could stimulate economic growth by providing long-term capital for investments if there existed a strong demand for equity-financed capital or if the process of industrialization was well established. The data pre- sented indicate, however, that neither condition exists in Panama at the present time. STOCK MARKETS AND DEVELOPMENT: A CASE STUDY OF PANAMA By Nicholas John DeGrazia A DISSERTATION Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Economics 1974 "er-r . ‘T'F‘m‘é © COPYRIGHT BY NICHOLAS JOHN DEGRAZ l A 197‘! . 933-. will anh:.io‘_ .. 4 Dedicated to Diane ii who was dent. h the agen finance Novins f gratituc. the task Securitir facilitit Detroit 1 include ‘ Redlin. y. i fill to K; J me dirEQ: ECOnOmy . ACKNOWLEDGMENTS First, and foremost, I am grateful to Milton Taylor who was my thesis advisor, travelling companion and confi- dant. He was also most instrumental in obtaining funds from the agency for International Development which were used to finance several trips to Panama.9 Wilmot Averill, George Lindahl Jr. and Malcolm Novins from the USAID mission to Panama also deserve my gratitude. Their assistance and gracious hospitality made the task much more pleasant. I am indebted to Roberto Brenes, Director, National Securities Commission of Panama for providing me with office facilities and inumerable contacts within the public and private sectors of Panama. I am grateful to my colleagues at the University of Detroit for their many comments and suggestions. These include Desire Barath, Larry Bossman, Rikuma Ito and Robert Redlin. For skilled typing of inumerable drafts, I am grate- ful to Kathy Calverly. James Reid, extrepreneur-at-large, constantly gave me direction and valuable insights into the Panamanian economy. iii Leonard and pati stantly despair. As members of the thesis committee, John Hunter, Leonard Rall and Harry Trebing displayed responsibility and patience, particularly during the early stages of writing. Finally, I am grateful to my wife, Diane, who con- stantly gave me encouragement during moments of joy and despair. iv DEDICATI ACKKOA E LIST OF NTRODUC Chapter ‘V .. ‘ a II. {’1 III_ , TABLE OF CONTENTS DEDICATION ACKNOWLEDGMENTS LIST OF TABLES INTRODUCTION Chapter I. FINANCE AND THE ROLE OF CAPITAL MARKETS IN ECONOMIC DEVELOPMENT . . . . . The Gurley and Shaw Theory of Finance The Need for Capital Markets . Theoretical Functions of a Corporate Stock. Market . . Restatement of the Gurley and Shaw Theory of Finance . . . . . . . II. ECONOMIC AND POLITICAL CHARACTERISTICS OF PANAMA Introduction . . Economic Growth and Inflation . Balance of Payments Money and Banking . . Manufacturing and Commerce . . Economic Benefits of the Canal Zone . Poverty and the Distribution of Income . Employment and the New Labor Code Current Political Environment . Summary III. EXTERNAL FACTORS AFFECTING THE SUPPLY OF AND DEMAND FOR EQUITY-FINANCED CAPITAL Introduction Primary and Secondary Capital Markets Organized and Non- -Organized Stock Markets Capital Markets in Panama V Page ii iii vii mO‘KUIU'I Chapter IV. VI. APPEI-JD: BIBLIOG Chapter Page Mbnetary Financial Institutions . . 74 Commercial Banks and the Indirect Financing Process . . . . . 82 Non- -Monetary Financial Institutions . . . . 84 Non-Monetary Financial Institutions and Indirect Financing Techniques . . . . . 87 Panama as a Regional Financial Center . . . 90 Regulatory Framework . . . . . . . . 92 Estimates of Savings in Panama . . . . . 97 Alternatives Available to Savers . . . . . 98 Summary . . . . . . . . . . . . . 102 IV. INTERNAL FACTORS AFFECTING THE SUPPLY OF AND DEMAND FOR EQUITY-FINANCED CAPITAL . . . . 107 Introduction . . . . . . . . 107 Sources of Financial Data . . . . . . 108 Financial and Statistical Measures . . . . 112 Analysis of Financial Ratios . . . . . . 114 Results of Questionnaire . . . . 125 An Explanation of Financing Behavior . . . 127 A Note on Insolvency Risks . . . . 129 Types of Business Enterprises and Capital Needs . . . . . . . . . . . . . 131 Summary . . . . . . . . . . . . . 134 V. ORGANIZED STOCK MARKETS AND ECONOMIC GROWTH . . 142 Introduction . . . . . . . 142 A Mistaken Historical Analogy . . . . ‘ 143 Characteristics of Latin American Stock Markets . . . . . 146 Elements of a Successful Stock Market . 154 Guidelines for Economic Growth and Development 156 VI. SUMMARY AND CONCLUSIONS . . . . . . . . 161 APPENDICES . . . . . . . . . . . . . . . 165 Appendix A . . . . . . . . . . . . 166 Appendix B . . . . . . . . . . . . 168 Appendix C . . . . . . . . . . . . 172 Appendix D . . . . . . . . . . . . 176 BIBLIOGRAPHY . . . . . . . . . . . . . . 179 vi Table 2.1. 2.2. 2.3. 2.4. 2.5. 2.6. 2.7. 2.8. 2.9. 2.10. 2.11. Table 2.1. 2.10. 2.11. 2.12. 2.13. 2.14. 3.1. LIST OF TABLES Average Annual Growth Rates of GNP of 18 Latin American Countries, 1960—1971 Sectoral Distribution of Gross Fixed Capital Formation . 1967-1972 . 1960-1971 Price Indices, Balance of Payments, Deposits and Loans Outstanding for Banking System, 1966—1972 . . Growth Rates of Deposits and Loans Outstanding for Banking System, 1966-1972 Loans Granted by Banking System, 1966-1972 Growth Rates of Loans Granted by Banking System, 1966- 1972 . . . Gross Value of Industrial Production at Market Prices by Type of Activity, for Selected Years . . . . . . . Value of Imports, Exports, and Re-Exports from the Free Trade Zone, 1967-1971 Estimated Gross Payments and Income Flow to the Republic of Panama from the Canal Zone, 1967-1972 Patterns of Income Distribution in Latin America . Summary Statistics of Income Distribution in Panama, 1970 Employment by Sectors, 1968-1971 Banks Operating in Panama Classified by Nationality, 1973 vii Page 17 18 20 23 28 29 31 32 35 40 42 46 47 50 75 Table 3.2. 3.3. 3.4. 3.5. 3.6. 3.7. 3.8. 3.9. 4.1. 4.2. 4.3. 4.4. 4.5. 4.6. 4.7. A .4 Table 3.2. 3.3. Classification of Assets of Banking System in Panama, 1965-1971 . . . . . Classification of Liabilities of Banking System in Panama, 1965-1971 . Types of Investments and Rates of Return on Investments Held by National and Foreign Insurance Companies, 1970 . Investment Portfolio of Desarrollo Industrial, S. A. Registered at the Cost of Acquisition, 1970- 1971 . . . . . . . . International Financial Centers, 1973 Gross Domestic Capital Formation and Savings 1967-1971 Capital Formation and Saving, 19 Latin American Countries, 1964-68 . Summary of Principal Local Financial Investments Available to Panamanian Savers, 1972 Classification of Business Firms According to Net Taxable Income, 1970 Industrial Classification of Sample Data Averages of Financial Data from Sample of 100 Largest Non-Financial Firms, 1970 Averages of Financial Data Collected from Random Sample of 155 Non-Financial Firms, 1969-1971 Total Debt/Total Asset Ratios for Non- Financial Firms from Selected Countries Average Rate of Return on Equity After Taxes for Non-Financial Firms in Selected Countries Number of Licenses Issued in Panama and the Amount of Declared Capital by Type of Economic Activity, 1970 . . Characteristics of Manufacturing, Commercial, and Service Establishments with Five or More Employees, 1971 viii Page 80 81 88 89 93 99 100 101 109 111 115 116 119 122 133 135 Table 5.1. 5.2. A1. B.l. Table Page 5.1. Indicators of Stock Exchange Activity in Eight Latin American Countries, 1962 . . . . 147 5.2. Price Indexes of Shares Listed on Various Latin American Stock Exchanges, 1959-1967 . . . 151 A.l. Descriptive Statistical Summary of Financial Data from 100 Largest Non-Financial Firms, 1970 . . . . . . . . . . . . . . 167 3.1. Descriptive Statistical Summary of Financial Data from 155 Randomly-Selected Non- Financial Firms, 1969-1971 . . . . . . 169 ix of an 0: develop: dissert. Organiz. cial de* that Pa; Present is a he Panaman institu mediari that Ca the Sall ecOnomi EOOdS a will be foundati of an i firms f GUI-18y INTRODUCTION This dissertation presents an analysis of the role of an organized stock market in the economic and financial development of the Republic of Panama.1 The purpose of the dissertation is to determine if the establishment of an organized stock market could enhance the economic and finan- cial development of Panama. The hypothesis to be tested is that Panama should adopt an organized stock market at its present stage of economic development because: (1) there is a need for equity-financed capital on the part of Panamanian business firms; (2) there are many financial institutions willing and able to act as financial inter- mediaries; (3) there is an ever-increasing supply of savings that can be expected to flow into business firms through the sale of stock; and (4) a stock market will promote economic development by increasing the capacity to produce goods and services.2 To test this hypothesis, a number of related issues will be discussed. Chapter I presents the theoretical foundation upon which the analysis is based. This consists of an identification of the processes by which business firms finance their capital expenditures as stated in the Gurley and Shaw theory of finance.3 This theory places emphasis upon the role of financial institutions, such as commercial banks, in the financing of capital expenditures. In contrast to the Gurley-Shaw theory, this dissertation emphasizes the role of an organized stock market in the financing of capital expenditures and how this can affect economic and financial development. A model is presented which assumes that the need for a stock market is dependent upon the demand for and supply of equity-financed capital. The model also assumes that the demand for and supply of equity-financed capital is dependent upon factors internal and external to the business firm. Chapter II describes the economic and political characteristics of the Republic of Panama. Since change does not occur in a vacuum, a description of the economic and political characteristics of the economy is necessary. In a socialistic environment, for example, a stock market is not a feasible method of raising long-term capital funds because the private ownership and exchange of financial assets does not exist. In Chapter III, the external factors that affect the demand for and supply of equity-financed capital are analyzed. The external factors that affect both the demand and supply side include the types of existing financial institutions, the structure of existing capital markets, and the regulatory framework in Panama. The external factors that affect the supply side include the volume of savings, the pro; native : externai finance. are the capital the den! busines Latin ;5 05 econ Cation_ organiz finance (2) fin gen6ra1 StOCk O nifican Stock n the propensity to save, and the rates of return on alter- native forms of savings. It is assumed that there are no external factors that only affect the demand for equity- financed capital. The internal factors that affect the demand for and supply of equity-financed capital are analyzed in Chapter IV. Internal factors that primarily affect the demand side are the types of business firms in the economy and their capital needs. The only internal factor that affects both the demand and supply side is the financial position of the business firms. Chapter V discusses organized stock markets in other Latin American countries and how they relate to the process of economic growth. Chapter VI presents the conclusions of the disser- tation. It will be shown that Panama should not adopt an organized stock market because: (1) a need for equity- financed capital by Panamanian business firms does not exist; (2) financial institutions such as commercial banks are generally unwilling to purchase the common or preferred stock of local businesses; (3) it is unlikely that a sig- nificant supply of savings will flow into an organized stock market; and (4) an organized stock market will not enhance the economic development of Panama. growth wi of incorz. memploy: economic "What Ar“ Studies, mil as an ex: tutions . through . stockhol of F' %. FOOTNOTES--INTRODUCTION 1Economic development can be defined as economic growth which is accompanied by a more equal distribution of income, a reduction in poverty, and/or a reduction in unemployment. For a discussion of the distinction between economic growth and economic development, see Dudley Seers, "What Are We Trying To Measure," The Journal of Development Studies, Special Issue on Development Indicators, VIII, No. 3 (1972), p. 21. Financial development can be defined as an expansion of the number and types of financial insti- tutions and financial assets in an economy. quuity-financed capital funds refer to funds obtained through the sale of common or preferred stock such that the stockholder owns a share of the business. 3John G. Gurley and Edward S. Shaw, Money in a Theory of Finance (Washington, D.C.: Brookings Institution, 1960). 0f finar methods economy _ I can fina finance_ 0111: of C IIIlits b0 L1nits, 4 “11039 de: inCOme, SUrpluS . EXCeedS i funds. “it iSs: CHAPTER I FINANCE AND THE ROLE OF CAPITAL MARKETS IN ECONOMIC DEVELOPMENT The Gurley and Shaw Theory of Finance John G. Gurley and Edward 8. Shaw developed a theory of finance that examined the saving-investment process and methods by which investments are financed in a developing economy.1 According to the Gurley-Shaw model, business firms can finance their investments or capital expenditures through three processes: self-finance, direct finance, and indirect finance.2 Under self-finance, firms finance their invest- ments out of retained earnings and depreciation, that is, out of corporate savings. Under the direct finance process, deficit spending units borrow capital funds directly from surplus spending units. A deficit spending unit is a business enterprise whose demand for spendable funds exceeds its savings from income, thus the enterprise demands loanable funds. A surplus spending unit is an individual saver whose income exceeds his expenditures, thus the saver supplies loanable funds. In the process of-direct finance, the deficit spending unit issues a primary security to a surplus spending unit in exchange debt an coon-on notes a. primary the def i 01' to 1'6 111g unit institu: t0 surpl type inc mutual f finance institUt issue inl amounts 1 “flu in, a Claim (I 1 limits 0.. & Capital TJ referl’eci exchange for cash. These primary securities include all debt and stock issues of deficit spending units such as common or preferred stock, bonds, mortgages, promissory notes and debentures. The surplus spending unit holds the primary security in anticipation of a rate of return while the deficit spending unit uses the cash to purchase assets or to reduce liabilities. Under the indirect finance process, a deficit spend- ing unit borrows from a monetary or non-monetary financial institution which, in turn, issues indirect financial assets to surplus spending units. Financial institutions of this type include commercial banks, savings and loan associations, mutual funds, life insurance companies, credit unions, finance companies and investment banks. These financial institutions accept money from surplus spending units and issue indirect financial assets which include savings accounts, mutual fund shares and other equities. Thus, under indirect financing, the surplus spending unit acquires a claim on the financial institution rather than, as in the case of direct financing, on the deficit spending unit. The Need For Capital Markets As the capital requirements of a firm go beyond the limits of self-finance, the need for capital markets arises. Capital markets--or securities markets as they are usually referred to--can be defined as those places where buyers an sel actions primard markets capital issuing to surgl ECOHQQ: corPor “QCord. establ. type 0 ECQnOm1 and sellers of primary securities negotiate financial trans- actions. Such markets provide the mechanism by which primary securities can be exchanged for money. Thus, capital markets provide the business firm with another source of capital funds. The business firm can raise these funds by issuing capital stock or debt, either directly or indirectly to surplus spending units. It should be noted, however, that the existence of a securities market does not imply the existence of a corpo- rate stock market. A corporate stock market is a specific form of securities market where only shares of common or preferred stock are purchased or traded. By definition, a securities market exists at the moment a business firm acquires capital funds, either directly or indirectly, from surplus spending units. Such funds, however, may not be derived from the sale of common or preferred stock. In effect, all corporate stock markets are securities markets, but not all securities markets include a corporate stock market. As security markets are developed in a growing economy to supply the capital requirements of business firms, corporate stock markets may or may not be established. According to the Gurley and Shaw theory, the decision to establish a corporate stock market is dependent upon the type of financial institutions already functioning in the economy as well as on the existing demand to increase various tions a in the primary establi cal.3 amount of a st useful have a bltiVe inVEStC reaard: the Pri allOCat funds by Cha. run capita: tutiOn an all various types of primary securities. If financial institu- tions are willing and able to act as financial intermediaries in the indirect financing process or as final purchasers of primary securities in the direct financing process, then the establishment of a stock market may be feasible and practi- cal.3 If the demand for capital funds has surpassed that amount provided by existing primary securities, the creation of a stock market may, theoretically, serve a number of useful functions. Theoretical Functions of a Corporate Stock Market Gurley and Shaw maintain that all securities markets have a distributive and allocative function. The distri- butive function is to disseminate information to savers and investors. The markets telegraph information to investors regarding the asset preferences of savers and make known the primary security issues of investors to savers. The allocative function is to increase the quantity of capital funds available to businesses which seek tangible assets by channeling money from savers to investors. In the long run, these markets provide flexibility in the financing of capital needs and permit a more intensive mobilization of domestic savings than may be provided by financial insti- tutions alone. Stock markets, as securities markets, can perform an allocative and distributive function if there is an appropr hmds. savings ves tors through on the 1 be expei availab assets savings PIOduct Working competi provide Savers. Stagna: I appropriate supply of and demand for equity-financed capital funds. Savers must be willing and able to divert their savings into shares of common or preferred stock, and in- vestors must be willing and able to acquire capital funds through the sale of such stock. If such a willingness exists on the part of both savers and investors, stock markets can be expected to: (1) increase the supply of capital funds available to businesses for the acquisition of productive assets such as new equipment; (2) direct the flow of new savings, domestic and foreign, toward businesses with a productive use for the funds; (3) effectively increase the working capital of business enterprises; (4) generate a competitive rate of return on the shares purchased; (5) provide liquidity for the shares of stock exchanged amongst savers. According to the Gurley and Shaw theory, if the need for capital funds goes beyond the limits of the self-finance process and securities markets do not arise, the economy may stagnate. In a stagnant economy, the production or import- ation of capital goods, such as machinery, is needed only to replenish the stock of capital as it wears out. Under such circumstances, depreciation allowances and retained earnings will provide the necessary capital funds. In a developing economy, however, positive net capital formation must occur such that net additions are made to the stock of capital. Direct and indirect financing through securities markets additior demand : factors tutions model of; Within g_ for EQUI for an 6 units, a The demg for cap: StOCR. referS t 10 markets could generate the capital funds for these net additions. Restatement of the Gurley and Shaw Theory of Finance In contrast to the Gurley and Shaw theory, the demand for an organized stock market may be dependent upon factors other than the existing or planned financial insti- tutions in the economy. This dissertation pr0poses a model whereby the decision to establish a stock market within a developing economy is dependent upon the demand for equity-financed capital by business firms, the demand for an alternative form of savings by surplus spending units, and the available supply of equity-financed capital. The demand for equity-financed capital refers to the demand for capital funds derived exclusively from the sale of stock. The available supply of equity-financed capital refers to savings that can be expected to flow into an organized, corporate stock market. It is further proposed that the demand for and supply of equity-financed capital is dependent upon factors which are internal and external to the business firm. The external factors that affect both the demand for and supply of equity-financed capital are the types of existing financial institutions, the structure of existing capital markets, and the regulatory framework. The external factors that only affect the supply of equity-financed capital are 11 the volume of savings, the propensity to save, and the rates of return on alternative forms of savings. The rationale for including the proposed external factors in the model can be given in terms of the financial community's ability to meet the capital requirements of the business community. If there is a sufficient number of financial institutions--such as commercial banks and savings and loan associations--that are able to meet the capital requirements of the business community with loans or other debt instruments, there would be no need for equity-financed capital. If the processes of indirect and direct financing through existing capital markets are meeting the capital needs of businesses, there would be no need for a corporate stock market. Likewise, if no regulatory framework exists to protect the rights of stockholders, the ability to raise funds through the sale of stock will be limited. The volume of savings, the propensity to save, and the rate of return on savings affect the supply of equity- financed capital for a number of reasons. If the volume of savings and/or the propensity to save is low for the economy, all forms of direct and indirect financing tech- niques will be ineffective in satisfying the demand for capital. Such a situation would hinder the successful operations of a stock market since savings would not be available for the purchase of stock. Likewise, if savers are receiving rates of return on savings deposits or foreign 12 securities that are greater than the current or expected rate of return on domestic shares of stock, it is unlikely that they will be willing to buy the domestic shares. The internal factors that primarily affect the demand for equity-financed capital are the types of business firms in the economy and their capital needs. The only internal factor that affects the demand for and supply of equity- financed capital is the financial status of the business firm. The rationale for including the proposed internal factors can be given in terms of the profitability of buying or selling corporate stock. If the business firm is not excessively leveraged, it may be more profitable to acquire 4 If the more capital debt than to issue corporate stock. nature of the business firm's operations requires a short- term, frequently occurring demand for capital funds, the sale of common or preferred shares of stock may not be the most expeditious solution. Corporate stock issues generally require several months of preparation due to legal require- ments. The analysis of the internal and external factors will proceed under three assumptions. First, the saving- investment process is assumed to be present to the extent that there are clearly defined savers and investors in the economy. Second, a business community exists with a demand for capital funds that goes beyond the limits of self-financing 13 techniques. Third, the economy is growing as measured by a rising gross domestic product in real terms. Each of these assumptions will be considered in Chapter II. FOOTNOTES--CHAPTER I 1John G. Gurley and Edward S. Shaw, "Financial Aspects of Economic Development," American Economic Review, XLV (September, 1965). 21bid., p. 518. 3John G. Gurley and Edward S. Shaw, Money In A Theory of Finance (Washington, D.C.: Brookings Insti- tutions, 1960), p. 123. 4 An excessively leveraged firm.would have too much outstanding debt relative to its equity. The equity of the firm.includes retained earnings and the value of outstanding shares of stock, if any. A discussion of the profitability of acquiring debt versus a stock issue will be presented in Chapter IV. 14 CHAPTER II ECONOMIC AND POLITICAL CHARACTERISTICS OF PANAMA Introduction The role of a stock market in a developing country is largely dependent upon the country's stage of economic and financial development. In a barter economy, for example, or in an economy with little savings, a market designed to transfer funds among savers and investors would serve no useful function. If there is a growing money economy, however, and the saving-investment process has been estab- lished, a stock market may further economic development for reasons presented in Chapter I. Thus, before the factors that affect the demand for a stock market are ana- lyzed, the stage of economic and financial development in Panama should be considered. This Chapter discusses the major economic and political characteristics of the Republic of Panama in order to determine its stage of economic and financial development. Emphasis is placed upon those characteristics that are: (l) necessary for the testing of the hypothesis as stated in the Introduction; and (2) representative of the economic strengths and problems in Panama. 15 (in cc rate 0 in Tab annual annual Countr: to incr In the increas tively Percen‘ of GDP in l97r SECtors defltiaj the Dr? aCCOHn Capitad increai PEriOd and 41 The Pr~ Somewm andea. 16 Economic Growth and Inflation The gross domestic product of the Republic of Panama (in constant 1960 balboas) increased at an average annual 1 As indicated rate of 7.9 percent between 1960 and 1971. in Table 2.1, this growth rate is greater than the average annual rate for 18 Latin American republics and the average annual rate for the Central American Economic Community Countries for the same period by approximately 2.5 percent. The economic growth in Panama is primarily traceable to increases in investment by the public and private sectors. In the periods 1960-65 and 1965-70, private investment increased at rates of 9.8 percent and 15.3 percent respec- tively while public investment increased at rates of 14.8 percent and 21.0 percent.2 Total investment as a percentage of GDP increased from 16.3 percent in 1965 to 27.1 percent in 1970. Most of this investment by the public and private sectors has been in urban infrastructure and in new resi- dential and non-residential construction. Investments of the private sector, as indicated in the data of Table 2.2, accounted for 76.4 percent of the increase in gross fixed capital formation during the period 1960-71. Of the total increase in gross fixed capital formation during this period, 58.8 percent was due to various types of construction and 41.2 percent was due to the purchase of capital goods. The private sectors contributions to this increase was somewhat evenly divided between construction (38.4 percent) and capital goods (37.9 percent). 17 TABLE 2.1.--Average Annual Growth Rates of GNP of 18 Latin American Countries, 1960-1971. GNP Per Capita Per Capita Growth GNP GNP Rate Growth Rate 1971 (3’4) (7.) (US $) Total 18 Republics1 5.6 2.6 530 CAEC2 5.5 2.2 355 Argentina 4.0 2.5 1,068 Bolovia 5.1 2.7 203 Brazil 6.5 3.5 394 Chile 4.8 2.7 854 Colombia 5.1 1.9 320 Costa Rica 6.3 2.9 539 Dominican Republic 3.8 1.0 356 Ecuador 5.2 1.7 267 El Salvador 5.5 2.0 294 Guatemala 5.2 2.1 354 Honduras 4.3 0.9 255 Mexico 6.8 3.3 670 Nicaragua 6.4 3.2 440 ____Panama L2 M 122 Paraguay 4 5 1.4 246 Peru 5.0 1.9 446 Uraguay 1.4 0.1 833 Venezuela 5.9 2.3 931 1Excludes Haiti. 2Central American Economic Community Countries (CAEC). Sources:‘ Latin American Economic Growth Trends prepared by the Office of Statistics and Reports, Bureau for Program and Policy Coordination--June, 1972. Gross National Product: Growth Rates and Trend Data by Region and Country, Office of Statistics and Reports, Bureau for Program and Policy Coordination, May 10, 1972. 18 TABLE 2.2.--Sectora1 Distribution of Gross Fixed Capital Formation. (Millions of 1960 Balboas) Z of the Increase 1960—1971 Occurring in this 1960 1965 1970 1971 Sector Total 61.4 97.1 221.9 254.7 Public 12.0 21.7 59.0 57.7 23.6 Private 49.4 75.4 162.9 197.0 76.4 1. Construction 38.9 51.3 112.5 152.6 58.8 Public 11.0 20.2 39.8 50.4 20.4 Private 27.9 31.1 72.7 102.2 38.4 Residential 14.9 20.2 46.4 59.5 23.1 Public 1.6 2.1 4.9 7.8 3.2 Private 13.3 18.1 41.5 51.7 19.9 Non-Residential Building 17.7 18.2 39.3 61.5 22.7 Public 3.5 5.7 9.3 12.6 4.7 Private 14.2 12.5 30.0 48.9 18.0 Other Construction 6.3 12.9 26.8 31.6 13.0 Public 5.9 12.4 25.6 30.0 12.5 Private 0.4 0.5 1.2 1.6 0.6 2. Capital Goods 22.5 45.8 109.4 102.1 41.2 Public 1.0 1.5 19.2 7.3 3.3 Private 21.5 44.3 90.2 94.8 37.9 Transport & Communications 8.8 15.3 45.7 39.3 15.8 Public 0.1 0.3 4.3 1.5 0.7 Private 8.7 15.0 41.4 37.8 15.1 Machinery, etc. 13.7 30.5 63.7 62.8 25.4 Public 0.9 1.2 14.9 5.8 2.5 Private 12.8 29.3 48.8 57.0 22.9 Sources: Direccion de Estadistica y Censos, Ingreso Naciona1L1960- 1968, pp. 42 and 43; Informacion Estadistica para la Conferencia Anual de la Asociacion Panamena de Ejecutivos de Empresas, CADE-l973, p. 20. 19 During the period 1960-72, the gross domestic product increased from B/415.8 million to B/1.04 billion (in 1960 balboas) or an increase of 151 percent. Three economic sectors accounted for almost one-half of this increase. The manufacturing sector accounted for 19.5 percent, wholesale and retail trade for 14.5 percent, and agriculture for 13.1 percent.3 For the same period, the average annual growth rates for these sectors were 10.3 percent, 8.2 percent and 5.3 percent respectively. Between 1968 and 1972, however, other sectors began to account for more than one-half of the growth in gross domestic product. Construction, finance and insurance, public utilities, and transportation and communication sectors showed the highest average annual growth rates during this period. The finance and insurance sector, for example, grew at an average annual rate of 20.7 percent between 1968 and 1972 while the public utilities sector grew at an average annual rate of 16.1 percent. The manufacturing sector, however, showed an average annual growth rate of 6.7 percent during the same period. Prior to 1972, these relatively high growth rates occurred in the absence of inflation. As indicated in Table 2.3, the consumer price index increased slowly between 1967 and 1972, with the exception of 1970. In 1972, however, the consumer price index increased by 5.5 percent to an index value of 120.2. In the same year, 20 .mnma .0 owumm .mmoamamm mufiumfipMumm .omcoo % moaumapmumm op cmwoooufio "mousom .auwo mamcmm :H moaawEmm maoucw anamoe paw 304m Am.s V Am.~ V Aa.onV Am.~ V AH.o V Am.q V Am.m V Am.H V Am.m V m.m~H m.~mH m.m~H o.m~H H.0NH ~.¢~H N.mHH ~.mHH A.mHH «.mou Hausoasuapma Am.HHV as.H-V Am.o V a~.~ V Am.o V Ao.m V Am.H V Am.H V As.H V m.o~H H.©~H m.A~H m.a~H o.q~H m.~HH m.moa H.mOH m.moa s.~ma HauuomseaH Ae.m V Am.o V Am.o V As.o V Am.~ V Am.m V Ao.q V Am.H V As.H V m.m~H o.HmH o.oma m.mNH m.m~a o.H~H m.mHH N.OHH ~.moa “.mOH monomeH Ao.m V fifl.o V As.o V A“.H V Ao.s V As.m V Ao.m V Ao.H V AA.H V H.m~H o.m~H m.mNH «.mNH N.©NH o.mHH o.NHH e.mOH o.AoH ~.moH mamas HH< mooaufimmaa Am.m V Am.m V As.o V Aa.m V Am.m V Am.o V Am.o V Ao.N V Am.o V o.m~H m.-H m.m~H m.m~u m.mHH ~.sHH ~.mHH m.moa m.mma o.mOH msoaameamomsz As.o V Aq.o V Ae.o V Am.~ V Ao.o V Am.a V Aa.orV Am.o V Ae.a V H.NHH m.mHH H.mHH s.NHH m.mOH m.~o~ m.moa o.oo~ H.mOH o.sOH wcamaom Ao.s V Ao.HuV Ao.H V Am.m V A~.H V As.~ V Am.~ V Aa.~ V Aa.m V s.s~H H.m~H m.m~H H.m~H N.HNH m.mHH H.©HH m.~HH m.oHH N.AoH mmwmua>am a uoom Am.m V A~.o V Am.o V An.~ V As.N V Aw.H V Ao.m V Am.H V Ao.H V ~.o~H H.-H m.H~H m.oNH H.5HH m.mHH m.HHH o.moa n.0oa o.aou mamas HH< mooaumomwm Nmma .uuo .uuo .uuo .uuo name came mama mama some mxmuaH mouum .mumasmaoo Haney nus cum mam umH mama .thalmoad .mmUchH mafiumll.m.N made 21 the wholesale price index increased by 8.6 percent to an index value of 128.1. The adequacy of the consumer price index as a measure of price changes throughout the country may be questioned. The index only measures price changes on goods and services consumed by low and medium income families living in Panama City. According to the 1970 census, approximately 387,000 people lived in Panama City or roughly 27 percent of the population. Thus, the index reflects the price changes of those goods and services consumed by less than 27 percent of the population. While it is difficult to quantify their impact, several factors exogenous and endogenous to the Panamanian economy contributed to the price movements between 1967 and 1972. Among the endogenous factors were the introduction of new indirect taxes and a new labor code. The price index for transportation rose by 15 percent during the first half of 1972 due to the increase in gasoline taxes, and the alcoholic beverage index rose by 10.9 percent because of the higher production taxes and import duties. The new labor code established in 1970 increased labor costs by raising the minimum wage and designating a compulsory "13th month" bonus for all employees. Among exogenous factors which affected price move- ments between 1967 and 1972 were currency realignments instituted in the Smithsonian Agreement of December, 1971, 22 substantial increases in commodity prices throughout 1972, and Panama's continued reliance upon imported goods. According to the International Monetary Fund, export prices of the industrialized countries rose 9.2 percent between the second quarter of 1971 and the second quarter of 1972.4 Panama's reliance on imports is partially reflected in the fact that 200 of the 328 items surveyed for the wholesale 5 price index are imported. In addition, the ratio of imports to gross domestic product ranged from 42 to 45 percent during the period 1967-72.6 At the 1972 meeting of Panamanian business executives, the Minister of Planning and Economic Policy stated that Panama could no longer hope to insulate itself from world inflationary pressures. The Minister indicated that a 7-8 percent annual rise in prices could be expected in the middle 1970's.7 Balance of Payments Panama has never been a major exporting country. Since 1960, exports comprised less than 12 percent of the annual gross domestic product. Although imports are usually much larger than exports, the trade deficit is offset to a large extent by income received from the sale of goods and services to the Canal Zone and tourists as well as the inflow of capital funds from foreign sources. Table 2.4 provides a listing of the type and value of exports shipped from Panama and the balance of payments (In Millions of Current Balboas) -1971. TABLE 2.4.-Balance of Payments, 1960 1966 1967 1968 1969 1970 1971 1960 -114.2 -123.1 -128.4 -152.5 -200.6 -223.4 - 69.2 Trade Balance 103.3 109.2 117.5 132.5 130.4 136.4 8.8 18.2 M Ex orts 49.5 57.6 63.4 61.8 62.9 .7 44 Bananas 25.9 22.9 18.8 24.0 21.5 25.1 Petroleum Shrimp 12.0 10.2 9.7 5.4 30.0 285.0 122.6 233.5 9.7 4.6 26.8 245.9 9.2 3.9 23.7 232.3 9.0 1.6 22.1 217.5 5.0 0.4 15.2 108.0 6.3 30.1 359.8 144.7 5.0 31.9 331.0 134.8 Sugar Other Imports (F. O. B.) Services, Net 95.2 113.1 210.4 83.0 161.1 301.8 266.0 122.5 143.5 131.2 189.9 89.3 Ex orts 23 84.5 100.0 112.5 122.0 126.6 175.2 .1 37.2 Canal Zone 89.9 97.9 111.5 76.6 Other Countries 157.1 110.9 Im orts 2.3 154.8 - 7807 2.3 128.9 2.2 108.7 - 29.9 2.2 95.1 - 15.3 2.1 92.6 - 27.9 2.0 76.1 - 31.2 3.1 45.3 - 28.3 Canal Zone Other countries 65.8 Deficit on Current Account H M H O\ O Unilateral Transfers 8.7 7.3 3.6 - 62.1 5.5 6.1 5.2 - 15.0 4.5 2.7 - 26.1 4.3 2.4 - 29.3 2.9 Canal Zone 5.0 - 75.0 4.9 - 28.7 2.0 - 27.4 Other Countries Total Current Account & Transfers 24 .waalqaa .mm .Nnma ..>oz .Hnmalmoma mmummo no mamcmm .momcou % mumummumumm mp cmwoomuwn "mouzom n.w «.mo I a.mm I m.H N.q I H.q 0.0 m:oammwao paw muouum uoz N.¢HN m.me o.m0a m.N~ m.H I w.mq o.H wmmumawnmmu cwwmuom cm mmmmuucH uwz .N m.HwHI ~.w~HI w.qa I 0.5H c.0a m.oq I m.m AIV muomm< cwmouom a“ mommwuucH uoz .H m.~m H.nm w.oa H.m m.qa o.~ m.o uoz .maowuauwumcH mRMuocoz m.H m.o 0.0 m.o II 5.0 m.H uoz .apwuluuonm w.Hm m.em m.em o.H e.~ e.m m.o udz .auduuweoq m.mm H.mm m.mm m.H q.~ m.q q.m uoz .ucmacum>ow .N «.0 «.6 c.c o.m m.H w.~ o.H uoz .Euouluuonm m.¢~ n.mm m.q~ n.ma m.HH q.om H.mH uoz .Euoulwaoq m.na m.mm m.mH H.mH «.mH 0.5H H.0H uoz .mum>wum .H e.Hm 4.0m m.Hm N.HH m.mH m.- m.u~ “dz .deeeeeeeeeeH mmmddeozreoz n.mw m.m~H o.~o m.oH m.om N.m~ o.wm uoz .maoam Hauwmmo Hmoa onma moma mooa mama owma coma .pmssHuGOUIl.q.N mam0 mouzufivcoaxm .0 mmm.m emu.m emm.e eNm.NH som.HH Nam.m meddmeem meow Hmcmo pow mmow>uom 0cm mwoow mo mamcmm am mommzousd mucuomuucoo .0 000.0 000.0 000.0 00H.0 000 000.0 muonuo m-.m 000.0 0m0.m 000.0 000 N00.0 Houuom mmw_0 «00.0 0m0_0 000.0H 000.0H qu.HH oaou Hmcmu :0 wcwumumao mcowumuficmwuo oun>Hum m0 mamcmm aw muoow mo mmmnuunm .0 Hem.m eHN.m cam.“ mHe.e mmw.e smm.m edde>udm «05.0N Hm~.wa mwm.0a m0m.ma 00~.0H 000.0H mvooo 0NH.0N 0wq.m~ nm0.¢~ 0mm_mm 000.HN N00.ma mofiocow< .m.0 an namcmm am mmmzuuna uuoufio .0 moe.m Nme.m mom.m Nea.e mom.m mee.e deedemdm mumawnmmflu 0am ucmamuwuom .N mas.em mmm.mm mmm.em emH.HA moe.me Hem.mm deed added as 0mzoaasm mucmvfinmu anacmsmsmm Ou 00mm wofiumamm 0cm mowm3 mmouu .H Numa Hmma 050a 000a 000H m0ma Ammonamm ucouuso mo wwcnmsoze aHV .NmmHIn0mH .mcom anamo oau aonm mancnm mo emanammm onu ou Scam oaoocH pan mucoaznm mmouo voumafiumMII.HH.~ mqmaum o.nq H.~H coo.Hm ooH.mo ooo.ao oo~.cm Hmuawaaum>oo m.om o.~ oom.oHH ooc.moH coo.ooH ccH.oo mmua>~mm m.cH o.~ ooo.oH oom.cH coo.mH cos.oa maofiumuacosaou wow owmuoum .uuoamamue o.m~ c.o ocN.cm ooc.Ho oom.cm con.Hm mucmuamummu can cacao: .momua o.H~ o.oH ooH.c~ oom.m~ com.o~ com.oa aofiuuouumaoo o.o o.m~ coc.o co~.c coo.m ooo.m “moms cam now .suaoauuumam o.H c.H ooH.oH ooc.o coc.c ooc.o «coo» macmuoo H.~H . ~.mu coo.~m ooh.~m ooc.Hm coo.mm mooom maomuaonaoz H.HH . o.~- cca.~o oco.~o ocm.Ho ooc.co wafiuouommoamz o o coo com coo coo mafia“: ~.~NH o.m ooo.cc~ oo~.o- occ.~o~ com.co~ mmaua>fluu< Hausuaauauwo a“ oumnm m.uouomm .Hhcanocoa .muouumm so cooasofloamuu.ofl.~ moo .moma .wowumwumum muczooo< Hmcofluuz wo xoonummw .mcoflumz nmufica “mummmw .ocncomau .molaoman .NOImooam «.mm o.m~ o.mm o.oa o.o m.mm o.aq «.mm mamsnwcm> o.mo o.m c.0H m.oHI m.om 0.0m o.NH knows»: w.~m N.n~ w.oH o.mm o.oq o.mm n.m~ pmvficwue om.~m oo.uo om.o om.ma o.MH o.nm . o.o~ magma w.¢m N.mo w.q w.o~ N.mN o.mq N.mH mmnwmumm a. 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I one. nonutuo>o a“ uaaoomwv m an Hawa moaoounxmam maom ooc.ao~o. uaaoxm xme Aamcasoa coo.o mozom ezmzzmm>oo one. Ono. Show pmxfim coo. aaaaxm ooc. same oaxam .uwmommp Show nowaoa mowoono on «w moon nonmas pom :mu uu>mmlxmwm Hmaaawz mmo. xma mmo. muqmoaoa mwow>mm zwuwuooaoo Amuauauma moumulluaowao>aoo zuo> ammo Hm uo>o Imonoamum 3amm mam: paw ooo.¢a\m Ho>ov xaam Hosanaz aaaaxm awe coo. . coo. aaaaoaao maae ucowam>coo >um> unusuamum xawm ham: Aooo.qa\m umuaov xmwm Hmawaflz moo. udaoxm me moo. mufimoamn mwaH>Mm mHHmommn Mzauouwmm Hmfiooam umum< Noe Noe mum .thH aflHMu/MW flmfiflafiwm 0U mHfimHHm>< muflmaum0>GH HQHUGNflHh HNUO‘H HQQfiUd—HHQ mo aumaaamuuoo macaw (5.9.. L 102 deposits of over B/14,000 fluctuate freely according to changes in the market supply and demand. Since Panamanian savers can place funds abroad without restriction, local interest rates must always be competitive with rates obtainable in international money centers. In 1972, bank time deposits of over B/l4,000 with maturity periods in excess of thirty-one days averaged 6.8 percent. For the small saver, ordinary bank savings accounts paid 4.5 percent while mortgage banks and savings and loan associations paid 5.5 percent in 1972. Savers also could purchase government bonds in the discount market with yields of 7 to 8 percent. The risk on these types of savings is minimal; banking facilities are well developed, and branch offices exist throughout the country. The total return on capital stock is the dividend yield plus any capital gains or losses. In general, it would not be correct to equate the dividend yield with the return on capital stock. Panamanian savers who purchase shares of stock, however, purchase for the long-run and only seem to be concerned with the dividend yield. In view of this assumption, the above use of dividend yield as a basis for comparison with other financial assets has some justification. Summary Capital debt issued in primary markets appears to be the most prominent type of capital funds in Panama. 103 Secondary stock markets are not active and do not represent a major source of capital funds. Primary stock markets are virtually non-existent. There are many monetary and non- monetary financial institutions capable of supplying equity- financed capital to businesses through the indirect financing nu process. Most of these financial institutions, however, do if not supply equity-financed capital because the rates of return on financial assets, such as loans and savings deposits, are higher than the return on common stock. A 7— regulatory framework has been established in the form of the National Securities Commission of Panama. The Com- mission was primarily organized to supervise the issuance and transfer of capital stock. Between 1970 and 1972, however, few companies had registered their outstanding shares of stock with the Commission. Panama has developed into a regional financial center that serves the financial needs of foreign and do- mestic enterprises. Although the center primarily acts as a haven for foreign capital, it does provide a number of economic benefits to Panama such as tax revenue. GrOSS' private domestic saving steadily increased between 1967 and 1971. The negative saving of households was offset by the positive saving of companies and the government. The greater proportion of savings in banks, however, came from foreign depositors. FOOTNOTES--CHAPTER III 1For a detailed discussion of primary and secondary capital markets, see Louis K. Brandt, Business Finance: A Management Approach (Englewoods Cliffs, N.J.: Prentice- Hall, Inc., 1965), Chapter 20. 2 3 41bid., p. 422. It is interesting to note that most brokerage firms consider themselves as investment banks. The major difference is that a brokerage firm acts as an underwriter and as a dealer in securities. It can buy and sell securities for customers and its own account. An investment bank, however, only acts as an underwriter. 5 6Although the supply of capital funds is equal to the amount of money being offered by surplus—spending units, the decision to supply capital funds is dependent upon the yield or rate of return on the securities. 7 8 Ibid., p. 412. Ibid., p. 420. Louis K. Brandt, Business Finance, p. 413. Louis K. Brandt, Business Finance, p. 414. Ibid., p. 416. 91bid., p. 417. 10Joseph Nacchio, in a private interview held in Panama City, Republic of Panama, July, 1972. 11Joseph Nacchio and Monty Motta, in private inter- views held in Panama City, Republic of Panama, July, 1972. 12One case, in particular, dealt with an American who began a travel agency in Panama City. After estab- lishing the agency, the American sought to import air- conditioned buses in order to conduct tours around the country. With the government's sanction, the buses were shipped to Panama. Later, Panamanian cab drivers lodged a complaint with the government that the buses were taking a significant portion of business away from them. The 104 [FIE-.1405 .3 .raflttvo #3:! J k. a a -41.. 5 105 government, in turn, forbade the use of the buses by the travel agency. After attempts to settle the issue failed, the American closed his agency and returned to the United States. The buses, however, remained in Panama. 13James Reid, in a private interview held in Panama City, Republic of Panama, August, 1972. 14Monty Motta, in a private interview held in Panama City, Republic of Panama, August, 1972. 15Meeting with representatives of U.S.I.F., Panama City, Panama, June, 1972. 16Ricardo Lay, in a personal interview held in Panama City, Republic of Panama, June, 1972. 17Welton Hewitt, in a personal interview held in Panama City, Republic of Panama, July, 1972. 18As mentioned earlier, Panama does not have a central bank. Bank deposits, therefore, are equal to deposits made by residents and non-residents. As shown in Chapter II, most deposits are made by non-residents. 19Ibid. 20Peter Treadway, "An Economic Analysis of the Feasibility of Creating an Underwriting Market-Making Fund in Panama" (unpublished report, Organization of American States, Washington, D.C., June, 1973). The public includes institutions as well as individuals in Panama. 21Superintendent of Insurance, Ministry of Commerce and Industry (unpublished material, Republic of Panama, 1973). 22 23Jose Chang-Hon, Peat, Marwick, Mitchell and Co. (unpublished report, Republic of Panama, May, 1972). 2"National Banking Commission, Statistical Bulletin (Panama: National Banking Commission, 1973). Ibid. 25Harry G. Johnson, "The Panamanian Monetary System, Euromoney, January, 1972, p. 48. 26Ibid., p. 50. 27 Thomas E. Weil, Handbook, p. 263. 106 28Peter Treadway, "An Economic Analysis," p. 18. 29Thomas E. Weil, Handbook, p. 265. 30Superintendent of Insurance, Ministry of Commerce and Industry (unpublished material, Republic of Panama, 1973). 31Thomas E. Weil, Handbook, p. 266. 32Desarrollo Industrial, S. A., Annual Report, 1971, p. 17. 33Ibid., p. 24. 34 Harry G. Johnson, "Panama as a Regional Financial Center" (unpublished report, USAID Mission, Panama, August, 1972), p. 2. 351bid., p. 6. 36Ibid., p. 42. 37 . Cabinet Decree Number 247, Ministry of Commerce and Industry, Republic of Panama (1970), p. 5. 38Ibid., p. 6-7. 391bid., p. 10. 401bid., p. 16. 411bid., p. 34. 42 Raymond Mikesell and James Zinser, "The Nature of the Savings Function in Developing Countries: A Survey of the Theoretical and Empirical Literature," Journal of Economic Literature, XI, March, 1973. 43For a lucid discussion of the mobilization of financial resources in Latin America, see Raymond W. Goldsmith, "The Mobilization of Domestic Resources for Economic Growth Through the Financial System," printed in The Mobilization of Internal Financial Resources in Latin America, Inter-American Development Bank, 1972. élv (- .. .. abriwiile. L. w». .53... 251... J“... .- CHAPTER IV INTERNAL FACTORS AFFECTING THE SUPPLY OF AND DEMAND FOR EQUITY-FINANCED CAPITAL Introduction The supply of and demand for equity-financed capital is dependent upon factors internal to the business enter- prise as well as upon external ones. The internal factors that primarily affect the demand side are the types of business firms in the economy and their capital needs. The only internal factor that affects both the demand and supply side is the financial characteristics of the business firm. The ability of the business firm to attract equity- financed capital funds is largely dependent upon the firm's profitability, debt to equity position, dividend rate, and ability to support interest charges.1 A low dividend rate in the absence of rising stock prices, for example, may provide a less than competitive rate of return to savers; thus, common stock becomes an unattractive source of capital funds. A large debt to equity position, however, may suggest that the business firm cannot afford more capital debt and should use equity-financed capital to satisfy capital needs. 107 108 This chapter discusses the internal factors that affect the supply of and demand for equity-financed capital. Financial data collected from business firms operating in Panama are presented as well as a cross-sectional analysis of the types of business enterprises established there. Sources of Financial Data In order to determine the financial characteristics of Panamanian business firms, balance sheet and income statement data were collected from two sources. First, financial data were obtained from the 100 largest non- financial business firms classified by net taxable income for 1970. These data included net sales, total assets, net income before and after taxes, retained earnings, paid— in capital and dividends paid. The second source was a random sample of 155 non-financial firms selected from those firms reporting a net taxable income greater than B/15,000 but less than the net taxable income of the 100th largest 2 firm for 1970. Data collected from this sample were the same as those of the first sample with two additions: depreciation expense for the year, and the interest paid.3 Although the first sample is cross-sectional data for the year 1970, the second sample is a time series for the years 1969, 1970, and 1971. As indicated in Table 4.1, approximately 5,400 business firms filed a corporate income tax form in 1970 109 TABLE 4.1.--Classification of Business Firms According to Net Taxable Income, 1970. Net Taxable Income (Balboas) No. of Firms Less than zero 825 .00 1204 .01 - 15,000 2240 15,000.01 - 30,000 484 30,000.01 - 100,000 487 100,000.01 - 500,000 144 500,000.01 - and up3 13 TOTAL 5397 8The highest net taxable income figure for any firm in 1970 was B/4,388,123. Source: Ministry of Finance, Republic of Panama, 1972. . V...» L n. 110 with 1,128 of these firms reporting a net taxable income greater than B/15,000 for 1970. This means that the combined sample of 255 firms accounted for 23 percent of those firms above the B/15,000 mark and approximately 5 percent of all non-financial firms filing a corporate tax form in 1970. The industrial classification of the two samples given in Table 4.2 indicates that the samples were dominated by commercial enterprises. The balance sheet and income statement data were collected from the corporate tax returns filed with the Ministry of Finance. All business firms are required to fill out a standard tax form and insert a copy of their balance sheet and income statement. Mest firms, however, only complete parts of the standard tax form and use several different forms to report the information usually found in financial statements. As a result, some firms present their financial status using very detailed accounting methods while others use very general methods and may include several different accounts under one general heading. For example, a firm may give a total amount for deductible expenses and not itemize each expense; or a single figure may be given for the amount of paid-in capital with no specification of the number of authorized shares, par value, or number of shares outstanding. Some firms fail to include any financial statements with their tax returns. As a result of these tendencies, tax return data may not 111 TABLE 4.2.--Industrial Classification of Sample Data. Type of Business Firm No. of Firms Percentage (Sample of 100 largest firms) Industrial 34 34.0 Commercial 63 63.0 Utility 1 1.0 Construction 1 1.0 Transportation 1 1.0 TOTAL 100 100.0 (Random Sample of 155 firms) Industrial 21 13.6 Commercial 125 80.6 Utility 1 0.6 Construction 5 3.2 Transportation 3 1.9 TOTAL 155 99.9 Source: Ministry of Finance, Republic of Panama, 1972. 112 be the most accurate source of financial data. Audited financial statements that follow standardized accounting principles would be a more accurate source. Corporate tax returns are, however, the only source of information re- garding the financial characteristics of business firms in Panama. The financial data from the 255 firms sampled here are presented in Appendices A and B. As an additional source of information, a question- naire was developed to determine the extent of equity owner- ship in Panama as well as the sources and uses of capital funds by Panamanian businesses. Graduate students from the University of Panama used the questionnaire to interview 50 executives from a random.sample of 50 non-financial firms that reported a net taxable income of B/15,000 or more in 1970. The questionnaire and results of the interviews are presented in Appendices C and D. Financial and Statistical Measures After the data were collected, a number of financial ratios were computed for each of the 255 firms. The ratios used to measure profitability for the firms were: the rate of return on capital before and after taxes, the rate of return on net sales after taxes, the rate of return on equity after taxes, and the ratio of net sales to total assets. The ratios used to measure the extent of insolvency risks were: the ratio of total debt to total equity, the ratio of total 113 debt to total assets, and the ratio of retained earnings to equity. In addition, the ratio of dividends paid to profits after tax and the times-interest earned ratio were computed for the random sample of 155 firms.4 Three statistics were used to measure the central tendency of the financial ratios: the unweighted arithmetic mean, a weighted mean, and the median. Since all of the distributions analyzed were skewed to the right, the unweighted mean represents a biased average due to the extreme values in the upper portions of the distributions. The weighted mean represents a more unbiased measure of central tendency since it accounts for differences in firm size.5 The median is also a more unbiased measure because it reduces the influence of extreme values. Even though the unweighted mean is biased because of the positive skewness, it does serve a useful function. If the weighted mean tends to be greater than the unweighted mean, this indicates that higher weights are associated with higher values of the ratio and vice versa. Therefore, if the weighted average of a debt to equity ratio were less than the unweighted average, firms with smaller equity positions would be associated with larger debt to equity ratios and firms with larger equity positions would be associated with smaller debt to equity ratios. If equity is used as a measure of firm size, it can be said that smaller firms have greater leverage than larger firms. 114 The statistical values of the financial ratios described above for the two samples are presented in Table 4.3 and Table 4.4. Since the unweighted mean is a biased statistic and since no single statistic can completely describe the financial status of the companies surveyed, the analysis of the financial ratios is based upon the weighted means and medians. The standard deviations around the arithmetic means are given in Appendix A. The size of the standard deviations indicates a relatively high degree of dispersion around the means. Analysis of Financial Ratios The risk of insolvency, defined as the probability that a firm will have an insufficient quantity of funds to meet future financial obligations, can be measured by the size of the debt to equity ratio.6 As the ratio increases, the risks of insolvency also increase indicating that the firm is acquiring more debt relative to its equity. Although there are no exact guidelines for interpreting this ratio, generally a ratio of 1:1 to 2:1 is indicative of moderate insolvency risks while a ratio greater than 3:1 is indicative 7 These guidelines vary, however, of high insolvency risks. from industry to industry. Business firms with a capital intensive production process, for example, will tend to have a higher debt to equity ratio than a service-oriented business. According to these guidelines, business firms included in the survey indicated low to moderate insolvency 115 TABLE 4.3.--Averages of Financial Data from Sample of 100 Largest Non- Financial Firms, 1970. Xa Xwa Mdc l. Debt-Equity Ratio 1.228 1.256 0.70 2. Total Debt to Total Assets 0.551 0.557 0.412 3. Return on Capital Before Taxes 0.208 0.097 0.190 4. Return on Capital After Taxes 0.134 0.068 0.102 5. Return on Equity After Taxes 0.251 0.132 0.178 6. Return on Net Sales After Taxes 0.115 0.066 0.085 7. Net Sales to Total Assets 1.588 0.880 1.316 8. Dividends Paid to Profits After Taxes 0.770 0.634 0.383 9. Ratio of Retained Earnings To Equity 0.532 0.533 0.550 aUnweighted arithmetic mean. bWeighted arithmetic mean where weights are the denominator of the ratio. CMedian. 116 TABLE 4.4.-~Averages of Financial Data Collected from Random Sample of 155 Non-Financial Firms, 1969-1971. 1969 1970 1971 xa 1. Debt-Equity Ratio 1.350 1.533 1.774 2. Return on Equity Before Taxes .352 .353 .258 3. Return on Capital After Taxes .197 .162 .161 4. Return on Equity After Taxes .260 .277 .208 5. Return on Net Sales After Taxes .170 .158 .112 6. Net Sales to Total Assets 1.898 1.515 1.645 7. Dividends Paid to Profit After Taxes .225 .400 .081 8. Ratio of Retained Earnings to Equity .524 .553 .559 9. Times Interest Earned Ratio 53.407 27.571 21.198 wa l. Debt-Equity Ratio 1.158 1.267 1.620 2. Return on Capital Before Taxes .087 .072 .062 3. Return on Capital After Taxes .072 .058 .048 4. Return on Equity After Taxes .154 .151 .125 5. Return on Net Sales After Taxes .072 .068 .048 6. Net Sales to Total Assets .228 .435 .465 7. Dividends Paid to Profit After Taxes .228 .435 .465 8. Total Debt to Total Assets .537 .559 .618 9. Ratio of Retained Earnings to Equity .451 .503 .498 Mdc 1. Debt-Equity Ratio .739 .756 .792 2. Return on Equity Before Taxes .233 .211 .182 3. Return on Capital After Taxes .095 .093 .087 4. Return on Equity After Taxes .197 .174 .151 5. Return on Net Sales After Taxes .103 .100 .075 6. Net Sales to Total Assets 1.178 1.074 1.089 7. Dividends Paid to Profit After Taxes 0 0 0 8. Ratio of Retained Earnings to Equity .558 .604 .610 9. Times Interest Earned Ratio 10.481 8.486 6.058 of aUnweighted arithmetic mean. bWeighted arithmetic mean where weights equal the denominator the ratio. CMedian. 117 risks for the years studied. For the sample of 100 firms, the ratio of total debt to equity indicated a weighted mean of 1.256 with a median of 0.700 for 1970. The sample of 155 firms showed weighted means of 1.158, 1.267, and 1.620 for the years 1969, 1970, and 1971. Two points are of interest with respect to these ratios. First, the weighted mean for the sample of 100 firms is approximately equal to its unweighted mean, while the weighted means for the sample of 155 firms are lower than the unweighted means. Thus, in the sample of 155 firms, firms with higher equity positions are associated with lower debt to equity ratios and vice versa. If equity is used as a measure of firm size, this relationship between the means indicates that smaller firms in the random sample tend to be more leveraged than larger firms. Second, the weighted mean and median of the debt to equity ratio have steadily increased over the period 1969-1971. The weighted mean increased at a rate of 16 percent per year while the median increased at approximately 4 percent per year. In addition, the average amount of stockholder equity steadily increased as given by the unweighted mean and median values in Appendix B. These variations indicate that, on the average, the amount of debt held by firms increased faster than the amount of equity during the period 1969-1971. In comparison to selected developed countries, Panamanian businesses appear to have been moderately or 118 even under leveraged. The ratio of total debt to total assets for seven developed countries is provided in Table 4.5.8 In 1969 and 1970, this ratio ranged from 0.516 to 0.853 for those countries surveyed. The ratio of total debt to total assets for the 100 largest firms in Panama showed a weighted mean of 0.557 for 1970. The random sample of 155 firms revealed a weighted mean of 0.537 and 0.559 for 1969 and 1970 respectively. The ratio of total debt to total assets for Denmark, Finland, Italy, Japan, and Sweden were significantly higher than that of Panama for the same period. This observation is somewhat sur- prising in view of the weak capital stock market and strong banking system in Panama. With such an arrangement, one would expect to find the Panamanian firms in a more leveraged position. A study undertaken by Investigacién Desarollo, S. A. (INDESA), a consulting firm located in Panama, also measured the extent of financial leverage among Panamanian firms.10 Based upon a sample of 25 non-financial firms, INDESA computed a value of 0.446 and 0.455 for the ratio of total debt to total assets in 1969 and 1970 respectively. Computed for commercial firms only, the ratios were 0.695 and 0.716 for 1969 and 1970 respectively. The average interest expense on the debt rapidly increased during the period 1969-1971, while the ability of the firms to support the interest expenses decreased. 119 TABLE 4.5.--Total Debt/Total Asset Ratios for Non-Financial Firms from Selected Countries. 1969 1970 Denmark All Non-Financial Sectors 0.660 0.665 Manufacturing Industries 0.637 0.649 Finland 0.733 0.748 Italy 0.715 0.749 Japan All Industries NA 0.853 Manufacturing NA 0.818 Sweden 0.717 NA United Kingdom Quoted 0.514 0.533 Non-Quoted 0.610 0.579 United States 0.516 0.517 Source: OECD Financial Statistics, 1972. 120 The unweighted mean interest expense for the sample of 155 firms increased from B/6,262 in 1969 to B/ll,345 in 1971, an increase of 81 percent. The times-interest-earned ratio,_ which measures the ability of the firm to support its interest charges, declined during the same period. The unweighted mean of this ratio declined from 53.4 in 1969 to 21.2 in 1971, while the median value declined from 10.5 in 1969 to 6.1 in 1971. In absolute terms, the business firms surveyed tended to be able to support the interest charges on the average, although this ability decreased significantly between 1969 and 1971. The profitability rates of the firms surveyed were measured by three financial ratios: the rate of return on capital or total assets, the rate of return on equity, and the rate of return on net sales. These measures were computed by dividing net income before and after taxes by total assets, equity, or net sales. As indicated in Tables 4.3 and 4.4, the weighted means and medians for both samples revealed after-tax profit rates ranging from 6 percent to 20 percent depending upon the measure used and the time period investigated. Between 1969 and 1971, however, the rates of return on capital, equity and sales decreased on the average. The decline can be attributable to a decrease in demand in the wholesale and retail trade sector, higher prices on imported goods that were not shifted forward in the form of higher 121 domestic prices, and the rise in interest charges during the 1969-70 period. In the sample of 155 firms, the weighted means of rates of return on capital, equity and sales, were sig- nificantly less than the unweighted means. In fact, in most cases the weighted means were less than the medians. This indicates that there were more smaller firms in the sample with higher rates of profitability than larger firms with higher rates of profitability. On the average, the smaller firms were more profitable than the larger firms in the random sample of 155 firms. In terms of the range and median values of the net taxable income of these firms for the period 1969-71, it appears that firms with a net taxable income between B/10,000 and B/35,000 had higher profit rates than those firms with a net taxable income greater than B/35,000 but less than B/200,000. This indication, coupled with the earlier inference that smaller firms in the sample of 155 firms were more leveraged (i.e., higher debt to equity ratios), leads to the conclusion that leverage tended to be profitable in Panama for firms in the B/10,000 to B/35,000 class between 1969 and 1971. Panamanian business firms also generated higher rates of return on equity during 1969 and 1970 than some developed countries. Average rates of return on equity after taxes for non-financial firms in selected developed 11 countries are provided in Table 4.6. The random sample 122 TABLE 4.6.--Average Rate of Return on Equity After Taxes for Non- Financial Firms in Selected Countries. 1969 1970 Finland 0.085 0.076 Japan All Industries NA 0.168 Manufacturing NA 0.166 Sweden 0.080 NA United Kingdom Quoted 0.089 0.088 Non-Quoted 0.091 0.097 United States 0.065 0.050 Source: OECD Financial Statistics, 1972. 123 of 155 non-financial firms showed a weighted mean of 0.154 and 0.151 for the after-tax return on equity in 1969 and 1970 respectively. The sample of the 100 largest non- financial firms showed an after-tax return on equity of 0.132 for 1970. Based upon the countries considered in Table 4.6, only Japan reported higher rates of return on equity after taxes in 1970. ' In further comparison, Fortune Magazine's 500 largest industrial firms showed a median of 0.046 for the return on sales after taxes in 1969. The industry median for the return on capital after taxes equalled 0.113. In 1970, the "Fortune 500" companies indicated an industry median for the return on sales after taxes of 0.039. The industry median return on equity after taxes was 0.095. The industry medians for the return on sales and the return on equity after taxes were 0.038 and 0.091 respectively in 1971. The relatively high profitability rates for Panamanian firms are indicative of a significant capacity for the self-financing of capital needs. Moreover, since the weighted means were uniformly lower than the unweighted means in both samples, it appears that the relatively smaller firms had a greater capacity for self-financing during the period 1969-1971 than larger firms. The dividend payout ratio, defined as the ratio of dividends paid to net profit after taxes, indicated 124 some interesting trends. In the sample of 100 firms, the weighted mean of the payout ratio was large in absolute terms (63.4 percent), less than the unweighted mean and greater than the median. The large absolute value reflects the presence of a number of U. S. subsidiaries that pay large dividends to other foreign subsidiaries or the parent company as a low-cost source of capital funds. When the subsidiary in Panama needs capital funds, it may receive a dividend payment from the parent company or another sub- sidiary. Besides certain tax advantages, this arrangement reduces reliance upon local capital markets for capital 12 funds. The fact that the unweighted mean payout ratio is greater than the weighted mean reflects the presence of many large firms that pay no dividends at all.13 In the sample of 155 firms, the weighted means for the three dividend payout ratios were higher than the unweighted means and medians. This reflects the fact that many of the firms in this sample paid no dividends between 1969 and 1971, and those that did were the larger firms in the sample.14 The dividend payout behavior expressed in the two samples is not unusual when one considers the personal and corporate marginal tax rates presently effective in Panama, as well as the fact that many Panamanian firms are not publicly owned. If a privately held firm has a net taxable income of B/40,000 or less, the owner has no tax advantage 125 in terms of paying himself a higher salary or paying himself a dividend out of higher net profits. The personal and corporate marginal tax rates are approximately the same at income levels below B/40,000. The owner may just as well keep the income subject to personal income tax equal to the amount subject to corporate income tax. After B/ 40,000 of corporate taxable income, it is more advantageous for the owner to pay himself a salary of no more than B/ 40,000 and take the remainder in the form of dividends. Since the firm pays a 10 percent withholding tax on 40 percent of the net taxable income whether dividends are paid or not, it is advantageous for the owner to take additional earnings from the firm in the amount of at least 40 percent of taxable income. When net taxable income reaches B/40,000, the personal marginal tax rate becomes greater than the corporate marginal tax rate and it is more profitable for the owner to take additional profits through a dividend payment rather than a higher salary. It should be noted that once the 10 percent withholding tax is paid by the firm, the dividend recipient need not declare the dividend as part of personal income. Results of Questionnaire The questionnaire presented in Appendix C was used to interview 50 executives from a random sample of 50 non- financial firms that reported a net taxable income of 126 B/15,000 or more in 1970. More than 25 of the 50 business firms surveyed were commercial enterprises. Since this type of enterprise is most characteristic of businesses in Panama, the random sample of 50 non-financial firms tends to be a representative sample. The completed question- naires revealed some interesting characteristics regarding capital financing behavior in Panama. First, 23 of the 50 firms surveyed were privately owned, while 21 were publicly owned where the majority of the stockholders were not employees of the company or relatives of management. The remaining 12 firms were publicly owned where the majority of the stockholders were not employees of the company or relatives of management. Second, 12 of the firms issued securities at least once in the past two years. Of these, 11 firms issued common stock and 6 of the 11 sold the stock to the directors, executives, or employees of the company. The remaining 1 firm issued bonds. Third, 41 firms expressed a preference to obtain external sources of capital by bor- rowing from financial institutions. Only 9 firms expressed a preference for the issuance of stock as a source of external capital funds. Fourth, 37 firms had 50 stock- holders or less; 33 had less than 26 stockholders. Fifth, of those 26 firms that obtained additional capital funds for their operations in 1970 and 1971, 6 firms financed the capital expenditures through short—term borrowing, 6 through long-term borrowing (maturity date in excess of 127 one year), 3 through the issuance of new stock, 5 through retained earnings, and 6 through a combination of borrowing, retained earnings, and new stock issues. Sixth, of those 26 firms that obtained additional capital funds for their operations in 1970 and 1971, 5 used the funds for the expan- sion of plant and facilities, 8 for an increase in inven- tories, 4 for financing accounts receivable, 3 for some- thing else, and 6 for a combination of the above uses. Seventh, 44 of the respondents said that all of their capital needs within the past two years were adequately supplied by the financial institutions in Panama. An Explanation of Financinngehavior A possible explanation and justification for the apparent preference of debt and retained earnings over equity capital can be found in a study by Gordon Donaldson of 20 U. S. business firms which indicated the following attitudes towards non-debt sources of capital funds:15 1. Management strongly favored internal generation as a source of new funds even to the exclusion of external sources except for occasional "bulges" in the need for funds. 2. Management considered the internal generation (of funds to be in the best interest of the existing stock— lnolders, (i.e., if new stock was issued there would be an :immediate decrease in earnings per share, cash dividends IDer share, market prices, and the price-earnings ratio). 128 3. The advantage of using funds already within full control of management, available without delay, uncertainty, negotiation, interference, publicity, explanation, or apparent cost to the shareholder, is important to management. The Donaldson study concluded that if management gives such priority to retained earnings as a source of funds, it may be that the potential gains of borrowing only become realized when internally generated funds prove inadequate to meet the need for capital funds. On the matter of debt capital, there are also in- centives that may account for the financing behavior of Panamanian firms. These incentives include.16 1. The use of debt relieves the current market of the direct threat of dilution due to more shares being traded. 2. Debt is normally a cheaper source of funds than retained earnings or new equity issues due to the tax shield of the interest charge. 3. There may be an uncontrollable peaking of mandatory expenditures which, when combined with other mandatory cash outflows, may at some point in time exceed internal resources. 4. The limited duration of the contractual arrange- ment and the relative ease of terminating the contract if and when means to do so become available is attractive. 129 5. Compared to arranging a new stock issue, the arrangement of a loan is significantly less bothersome and time consuming. 6. The maintenance of corporate privacy may have a high priority (i.e., no new stockholders). 7. If the purchasing power of the dollar is expected to deteriorate due to inflation, it is better to finance on the basis of fixed dollar commitments. 8. The firm may be conditioned to debt financing, have established channels of communication, and, therefore, seek to follow a familiar pattern. 9. There may exist a sizeable and aggressive financial community. All of these incentives are present in Panama to some extent. Many business firms are privately owned and have well-established banking connections. The recent inflationary pressure favors the financing of capital expenditures on the basis of fixed dollar commitments. The overdraft accounts offered by most of the 52 banks provide a flexible and easily arranged source of capital funds that is required to finance inventories and accounts receivable. A Note on Insolvency Risks Bankers in Panama City assert that many firms in 1Panama have debt-heavy financial structures and are running 130 high insolvency risks. They further assert that an increase in these risks indicates an ever-increasing demand for equity-financed capital. The results presented in this paper clearly indicate that the first assertion is incorrect. The combined sample of 255 firms indicated low to moderate insolvency risks both in absolute terms and in comparison to other countries. With respect to the second assertion, Orson Hart has observed that the economic functions of 17 First, these markets securities markets are two-fold. facilitate the exchange of outstanding securities and, second, they provide a structure to enable private firms and government to raise capital. But, according to Hart, the raising of capital has never been a major function of stock markets. Corporate enterprises have raised most of their capital through retained earnings and other sources outside the framework of the marketplace. Hart further contends that these sources of capital will not sustain the needs of American business much longer as manifested by the rising debt ratios of U. S. corporations. In 1950, long-term debt constituted 11 percent of the capital structure of manufacturing corporations as defined by the Federal Trade Commission. In 1960, the ratio was 16 percent and in 1971, 25 percent. New stock issues have increased to more than $13 billion in 1971 compared with an average of less than $2 billion per year during the 1960's. Thus, Hart assumes that an inevitable demand for equity-financed 131 capital is dependent upon changes in the debt positions or solvency risks of the firms. According to Hart, an increase in the debt-equity ratio indicates a demand for equity- financed capital. This relationship may not hold true for Panama in spite of the rising debt-equity ratios between 1969 and 1971 because of the extensive use of the overdraft system. The overdraft mechanism allows firms to acquire funds by drawing on their demand deposits in excess of the amount deposited by the firms. The bank places money into the firms' demand deposit account up to a negotiable limit and charges interest on the monies extended. The result is similar to equity-financing in the sense that there are no fixed maturity dates. Although the amount of the over— draft may be recalled by the bank at any time, such incidents were not observed during the period of analysis. Hence, the insolvency risks may not be as great as the debt-equity ratios may suggest.18 Types of Business Enterprises and Capital Needs The internal factors that primarily affect the demand for equity-financed capital are the types of business enterprises. Capital intensive industries that have a demand for new machinery or an expansion of plant facilities requiring a substantial sum of money would require some form of long-term financing; that is, the firm would need 132 capital funds with a 15-20 year maturity date or no maturity 19 In this case, a bond or stock issue might date at all. best satisfy the capital needs because of the long-term maturity date of a bond issue or the absence of a maturity date in the case of a stock issue. On the other hand, a commercial or service-oriented firm that needs capital funds primarily to replenish or expand inventories on short notice would require a source of funds that is quickly 20 In this case, a short-term loan and easily obtainable. from a financial institution or an overdraft mechanism would better satisfy the capital need. In order to determine the capital needs of busi- nesses, it is necessary to approximate the number and types of enterprises in Panama. Table 4.7 lists the number of licenses issued by the Ministry of Commerce and Industry and the declared amount of paid-in capital classified by type of economic activity. According to Law Number 24, established in 1941, all businesses except those that deal exclusively with the buying and selling of animals or prod- ucts from Panama and by Panamanians, must have a license to operate in Panama. Since approximately 90 percent of all businesses only have one license per business, the registry of licenses can serve as an approximation of the number of different enterprises in Panama as of 1970. As indicated by the data of Table 4.7, 88.7 percent of the licenses issued as of 1970 were in the commercial and service-oriented fields. 133 TABLE 4.7.--Number of Licenses Issued in Panama and the Amount of Declared Capital by Type of Economic Activity, 1970. No. of Declared Type of Activity Licenses Percent Capital Percent Agriculture, Fishing Hunting 64 0.3 25,311,898 6.4 Mining 35 0.1 3,140,500 0.8 Manufacturing 1,984 9.5 88,417,086 22.4 Public Utilities 12 0.1 32,858,345 8.3 Construction 265 1.3 10,314,465 2.6 Commercial Trade 16,299 78.0 132,683,763 33.6 Transportation, Warehousing, Communication 433 2.1 17,975,562 4.5 Finance, Insurance, Loan Companies 650 3.1 76,502,170 19.3 Community Services 1,151 5.5 8,329,025 2.1 TOTAL 20,893 100.0 395,532,814 100.0 Source: Direccién de Estadistica y Censo, Series "F.l" No. l, 1970, p. 56. 134 Additional characteristics of manufacturing, com- mercial and service enterprises that employed five or more employees as of 1971 are contained in Table 4.8. The commercial and service sectors are larger than the manu- facturing sector in terms of gross sales, employment, wages and salaries paid, and the number of establishments. In 1971, there were three establishments in the commercial or service sector for every one establishment in the manu- facturing sector. Commercial and service-oriented enter- prises primarily need capital funds to finance inventories and accounts receivable. The size and timing of such capital demands are unpredictable and occur frequently since they are affected by price fluctuations on inter- national markets and changes in supply factors abroad. This sporadic demand for capital funds is best satisfied by a short-term, capital-financing arrangement such as an over- draft mechanism. Summary An examination of the internal factors that affect the capital financing process used by Panamanian business firms leads to a number of relevant facts for the purpose of this study. First, data drawn from the sample of 255 non-financial firms indicated comparatively high profit- ability rates and low insolvency risks during the period 1969-1971. The fact that the debt-to-equity ratios were 135 TABLE 4.8.--Characteristics of Manufacturing, Commercial, and Service Establishments with Five or More Employees, 1971. Characteristics Total Manufacturing Number of Establishments 698 Persons Employed 25,179 Wages and Salaries 51,891,326 Value of Gross Sales 424,039,844 Commercial (Wholesale Only) Number of Establishments 504 Persons Employed 9,282 Wages and Salaries 24,354,083 Value of Gross Sales 412,122,896 Commercial (Retail Only) Number of Establishments 1,016 Persons Employed 14,481 Wages and Salaries 27,745,153 Value of Gross Sales 326,100,135 Service Number of Establishments 744 Persons Employed 10,364 Wages and Salaries 16,561,684 Value of Gross Sales 73,916,229 Source:’ Direcci6n de Estadistica y Censo, Diciémbre de 1972. Boletin No. 491, 26 de 136 low to moderate, coupled with the fact that many loans were granted to local firms between 1969 and 1971, indicates that business firms were able to acquire additional debt without jeopardizing their financial position. On the average, the insolvency risks increased between 1969 and 1971, indicating a rise in the acquisition of debt relative to equity. Even though the average amount of equity per firm increased between 1969 and 1971, the average debt-to- equity ratio increased faster. Second, during the period of analysis, there was a stated preference for the issuance of capital debt to finance capital needs rather than the issuance of capital stock. Equity ownership is not widespread among the public, and the firms interviewed seemed to prefer it that way. The acquired capital funds were primarily used to purchase inventories and to finance accounts receivables. Only a few firms were unable to supply a capital need satisfactorily with the existing financial institutions in Panama. Third, the business sector in Panama is characterized by a relatively large number of commercial and service- oriented enterprises. By their nature, these firms need capital funds primarily to finance inventories and accounts receivable. Such capital needs are unpredictable and occur frequently since they are affected by price fluctuations on international markets and changes in supply factors abroad. This sporadic demand for capital is better satisfied by a 137 source of short-term capital funds such as that provided by an overdraft mechanism rather than by the issuance of capital stock. FOOTNOTES--CHAPTER IV 1This functional relationship assumes that the rate of return to a surplus spending unit is related to the cost of capital to the firm. As the cost of capital rises, the ability of the firm to offer attractive rates of return via dividends or interest payments may decrease. As Modigliani and Miller have shown, in light of a progressive corporate tax structure, the debt-equity ratio does effect the cost of capital. See Franco Modigliani and Merton Miller, "The Cost of Capital, Corporate Finance and the Theory of Invest- ment," American Economic Review, June, 1958, pp. 261-297. 2The B/15,000 figure was chosen somewhat arbitrarily. The intent was to concentrate on those firms most likely to have a demand for equity-financed capital. It could be argued that a firm with a low net taxable income may not be in a financial position to "go public." 3The financial data for the two samples were col- lected at different times. At the time the depreciation and interest expenses were collected for the sample of 155 firms, there was insufficient time to gather the same infor- mation for the sample of 100 firms. In effect, the changes in the interest expenses over time, as indicated by the sample of 155 firms, is more meaningful than the cross- sectional counterpart. 4The times-interest-earned ratio is equal to gross earnings before interest charges and taxes divided by interest charges. The ratio is valuable to bond investors as a measure of the safety factor involved in any invest- ment calling for the payment of a fixed sum quarterly, semi- annually, or annually. A company should earn its interest charges a minimum of three or four times if its bonds are to be considered safe. A common stock investor should hesitate to purchase shares of a company with a low ratio of times-interest earned since a low ratio is an indication of financial trouble. 5Theoretically speaking, all arithmetic means are weighted means. If no specific weights are given to each and every value in the series, each value is assigned an equal weight of one. In averaging percentages or ratios, it is necessary to assign proper specific weights to the 138 139 values in the calculation of the mean in order to obtain an unbiased result. Consider, for example, the calculation of the mean of 50 debt to equity ratios for 50 different companies. If you summed the 50 ratios and divided by 50, you would obtain the average amount of debt to equity per firm. This calculation assumes that all 50 companies are of equal size with respect to the size of their equity since a weight of one was applied to each ratio in the calculation of the mean. To account for the differences in size as measured by the amount of equity, each ratio should be weighted by multiplying the ratio by the amount of equity. The summation of these products divided by the summation of the weights (size of equity) would equal the weighted mean or average amount of debt per unit of equity for all 50 firms. Mathematically, the weighted mean would equal the total amount of debt for the 50 companies divided by the total amount of equity for the 50 companies. In general, the weighted mean of a series of ratios where each ratio equals A/B is equal to WEB. The values of B, in effect, are the weights. 6The debt-equity ratio was computed by using both long-term and short-term debt. Long-term debt refers to an obligation with a maturity date that is longer than one year from the date of issue. Equity refers to the stock- holder's total worth in the business. It includes the value of capital stock, if any, and retained earnings. 7These general guidelines were made known through conversations with managers from Peat, Marwick, Mitchell, Inc., a CPA firm. For a general discussion of the subject, see Gordon Donaldson, Corporate Debt Capacity, Richard D. Irwin, Inc., 1971, pp. 8, 142. 8The relationship between the debt-equity ratio and the debt-asset ratio can be easily derived as follows: Let D=total debt E=total equity A=total assets Then, D=D/E (A-D) where E=A-D Also, D/AFD/E-(DxD/ExA) And, D/A + DxD/ExA = D/E And, D/A x (1+D/E) = D/E Therefore, D/A = (D/E)/l+D/E 9 One explanation for this observation is that although tine total debt of many firms is high in absolute terms, the 140 amount of retained earnings are sufficiently high to offset the large debt position. 10The title and date of publication of this source are unknown at this time. The author obtained this infor- mation from one of the consultants at INDESA. 11Such comparisons for other developing countries are not available due to the sparcity of research in this area. At the present time, however, the Organization of American States is sponsoring research identical to that contained in this thesis. Differences in tax rates between Panama and some developed countries account for part of the differences among rates of return on equity. 12Dividends are only taxed once at a rate of 10 percent. 13Net profits after taxes ranged from B/100,000 to B/2 million in this sample. Therefore, the smaller firms that did pay a dividend in this sample were in the B/100,000- B/130,000 range. The dividend ratios in both samples sug- gest that business firms with net profit after taxes between B/70,000 and B/l40,000 had the higher dividend payout ratios. 15 16 17Dr. Orson H. Hart, Vice President and Director of Economic Studies of the New York Life Insurance Company. These comments were made in response to the Second Buttonwood Lecture given by Professor Sidney M. Robbins, entitled "Some Reflections on the Central Market," sponsored by the Graduate School of Business, Columbia University and the New York Stock Exchange, Inc., 1972. Gordon Donaldson, Corporate Debt, pp. 68-80. Ibid. 18The exact number of firms that have an overdraft account as well as the sizes of such accounts are not known in Panama. Conversations with officers of four of the large banks indicates that most firms with gross sales in excess of B/50,000 per year have an overdraft account. It is a very common source of capital funds. 19Such'was the case of the development of the rail- roads in the United States where capital financing often included a combination of common stock, debentures, secured bonds, and income bonds. 141 20For a discussion on the cost and complexities associated with issues of capital stock and capital debt, see Louis K. Brandt, Business Finance: A Management Approach éggglewood Cliffs, N.J.: Prentice-Hall, Inc., 1965), pp. 411- CHAPTER V ORGANIZED STOCK MARKETS AND ECONOMIC GROWTH Introduction From the analysis of the external factors that affect the demand for and supply of equity-financed capital, it is evident that capital markets in Panama have enhanced economic growth by mobilizing financial resources and channeling them to investors. As stated earlier, deposits in the banking system increased by 500 percent while loans outstanding increased by 470 percent between 1966 and 1972. While it is true that more than 50 percent of the deposits have been attributable to non-residents, deposits from residents increased by 213 percent during the period from 1966 to 1972. During the same period, loans granted to residents increased by 318 percent. Although the banking community has furthered the economic growth of Panama, it is not evident at this point that an organized stock market will further mobilize capital funds for economic growth. This chapter discusses the possibility that organized stock markets will increase the mobilization of domestic resources for economic growth of a developing country. The discussion is based upon the experiences of other Latin American countries, such as Mexico, Colombia, and Brazil. 142 143 Although the economic and political characteristics of Panama are rather atypical, a brief discussion of the economic contributions and problems of stock markets in other Latin American countries will be useful in considering the possible role of a stock market in Panama. This chapter will also identify the elements that constitute a "successful" stock market, i.e. one that will increase the mobilization of domestic resources for economic growth beyond those provided by the banking system. A Mistaken Historical Analogy Raymond W. Goldsmith has questioned whether Latin American countries should place emphasis on direct financing techniques, particularly the sale of government and private securities to large numbers of savers which characterized the financial development of Europe and North America in the early 1900's, or on indirect financing through financial institutions.1 In Europe and North America, massive sales of stocks and bonds were made to private investors. The sale of securities to individuals was considerably in excess of individuals' savings through other financial institutions. These securities were essentially of three types: (1) long- term government bonds, (2) long-term bonds of mortgage banks and similar real estate credit organizations, and (3) long- term bonds and stocks of railroad corporations and indus- trial enterprises. 144 The factors that made the sale of these stocks and bonds to private investors crucial in the mobilization of resources for economic growth were the following: 1. Political stability prevailed and the decision to save was not materially influenced by considerations of substantial changes in a country's political or economic system. 2. The money illusion prevailed making it doubtful that savers were influenced by expected differences between nominal and real yields on securities.3 3. At that time, savers were more interested in income stability rather than in fluctuations of market prices. As a result, savers were willing to buy long—term bonds where the liquidity of their holdings was based upon open-market sales rather than upon redemption by the issuers. 4. Savers, at least in the financially secure countries, had complete confidence in the credit of their own governments and in that of large mortgage banks and private corporations. 5. The interest rates offered to bond-holders corresponded to market rates both for government and private issuers. 6. There existed a large rentier class willing and able to invest a substantial portion of its savings in long-term, fixed income securities. 145 7. Railroads, the most important non-government issuers of marketable securities, were relatively uniform and simple in their financial structure, their operations and prospects, and usually started out as sizeable publicly- owned corporations.5 In the light of these factors, it should be evident that the economic and political environment of Panama is not as it was in Europe or North America prior to World War I. The capital flights that occurred in Panama in 1964 and 1968 were manifestations of the effect of potential changes in the economic and political system on the decisions of savers in Panama. According to Goldsmith, the money illusion cannot still be held in most Latin American countries, and its disappearance will likely affect long- term, fixed income securities unfavorable in the future. Although it is probably true that Panamanian savers are interested in income stability, there tends to be a re- luctance to commit funds to long-term investments. Political uncertainties and the absence of liquidity generate a cautious attitude among savers. As indicated earlier, interest rates on government securities have not corresponded to rates obtainable on other financial assets. As a result, government securities have had to be placed with government agencies, foreign sources, or private financial institutions in Panama which were forced by government regulations to purchase the 146 securities. Goldsmith has observed that the liquidity preferences of private investors have been extremely high in Latin America. Investors have preferred short-term and fixed income securities or assets that could be redeemed for cash on short notice. Such a tendency does not favor the establishment of a bond or stock market with little or no liquidity.6 Characteristics of Latin American Stock Markets In contrast to Goldsmith's views, many Latin American countries have organized stock markets or stock exchanges as a supplement to existing capital markets. In Chile, Colombia, and Venezuela, there are two stock exchanges, while there are three in Mexico, four in Argentina, and 21 in Brazil.7 Generally speaking, the exchanges in the capital cities are the most important except in Brazil, where the exchanges of Rio de Janiero and Sao Paulo are the largest in the country. Although several of the Latin American stock exchanges have been in existence for many years, the volume of operations registered with these insti- tutions is relatively small.8 Table 5.1 gives indicators of stock exchange activity in eight Latin American countries for 1962. In general, these are the Latin American countries in which capital markets are relatively more developed. In the remaining countries, either no stock exchanges have been established, .cON .a .mm manmw .Aooaa .mcofiumz twang: “xuow 302v mofiuma< swung aw ucoaaoao>oa HmwuumspaH mo mmmooum one .mofiuma< sound you cowmmwaaoo UHSocoom "mouaom .uamuuoa m.o mm3 oaumu wawpaonmouuoo osu Head :Hn .uamoumn on was oHumu wowpaommouuoo onu coma aHm 147 . . Ammwmucoouoav meowuomwamuu o m.c OH m.o oq mm mmH om . . A Hmuou pom nonmam Hmfiuumspaw 5” maoauommcmuu domauon 03mm .q m.o H.o N.o o.~ m.H m.o . . . . . . uosvoum Hmfiuumopoa may tam moumnm Hmfiuumsvaw cw cowuommamuu amozuon owumm on H.O H.O Q.O H.O 0.0 5.0 «.0 «.H . . . . . . . . . . o . HUSUOHQ ofiumoaop mmouw vow mononm a“ aofiuommamuu nomauon owumm any H.H m.H m.o m.oa H.H w.o N.H m.a . . uuavoua uaumoaop mmouw cam mGOfiuummcmuu Houou omuauon oHumm Amv Amowmuaoouomv moowuommamuu mo madao> mo moamuuomaw o>wumaom .m on II ON wma no end Hmm . . . . . . . . . . HmwuumstH Anv Ha 'I mHH omm “OH NR” Nmm o o o 0.0 o o o o o o o o HQHOB Amv mofiommaou wouwumwwou mo nonadz .N H H H .m N N am m . . . . . mowsmnoxo Mooum mo umaasz .H mamauoam> mmswaub :Hom OUfixoz manEOHoo mafinu Hwnmum mcwuaowud .Nema .mofiuuaaoo amoHuma< sauna unwwm cw huw>fiuo< owamsuxm JUOum mo muoumowvaHll.H.m mqmuom amuocmo < "moauma< cauma Ca muoxumz amuamuu .amnmx oaaaz cam nommm macouc< .mxooum m>aumucomouaou umoa ca ocu mo wanna moaumo .oaamm mom cam oam mo momcmnuxo ecu co uo>ocusu ummwuma may cuas moauausomm NN ecu mo xmpca coaumuozo "mousom .mpcopa>av xuoum ma woumsnpm n .xmpca wca>aa mo umou ecu me wanna moaum mumnm ecu weaumamop me nonamunoo II II mm om mm Oaa No aoa no mmma m am mama on mm oq mm mm Oaa Na mm am Omaa m om coma mm mm mq mm aOa oaa mm moa No cam m mm mama mm mm mm om om QOa No maa mm mos ca ac coma ow am co ow mm mm mo ooa qqa awn ma mm mama me On mm mm mm om mm mm mma «om mm mm Noma on an mm cm om mm om om NNa amm co om aoma Nu mm mm ooa om aoa mm mm Nqa Nma mm om ooma ooa ooa 00a 00a OOa 00a 00a 00a ooa 00a ooa ooa mmma mxoUCa oxopca mxopca xopCa mxocca xopCH mxmch xouca mxmpca nxooCH mxopca xovca snow ouaum moapm ooaum moaum ouaum moaum muaum ooaum moaum ouaum moaum moaum amom oumnm amom wumnm amom oumcm amom oumcm amom uumnm ammm oumcm Amncmuaz mo oumum AmEaav Amuau ooaxwzv Awuowomv AOasmm mom a camv Ammua< mocosmv .mmomumov maosuoCm> spam ooaxmz mananoo aaumum mcaucmwu< Aooaummmav .nomaummma .mowcmnuxm xUOum cmoauoad cauma msoaum> co pouwaa moumnm mo moxmpCa ouapmll.m.m mammH 152 other countries, however, the real index of share prices declined sharply in the period from 1959 to 1967. In Brazil, stock prices showed an increase in real terms from.l959 to 1963, but then dropped sharply until 1967. The behavior of stock prices is important to the development of an efficient secondary market.15 Frequent short-run fluctuations can create mistrust and a lack of confidence in securities as an instrument of savings. Ideally, the development of a sound and active secondary market requires some fluctuations of prices over the short run in response to changing economic conditions, with a moderate and sustained upward trend over the long term. Reasonable price stability is one of the chief factors in attracting savers and investors to stock markets. Unfortu- nately, the price fluctuations on some Latin American stock exchanges in recent years have not been conducive to the purchase of securities by the public. Inflation, political instability, and fraudulent stock manipulations are mostly responsible for this price behavior on Latin American ex- changes. Finally, it should be noted that all of the characteristics of Latin American stock exchanges discussed here operate jointly to determine the degree of liquidity in the securities markets. As stated earlier, the princi- pal feature of a stock exchange is the operation of a secondary market that facilitates the mobilization of resources among individuals and institutional investors. 153 The secondary market must provide the assurance that long- term securities can be easily and quickly converted into cash. Latin American exchanges perform this function to a limited degree for only a few stock issues. Obviously, the liquidity in the secondary markets is directly related to the demand for and supply of equity-financed capital. There exists what might be called a "vicious circle of inadequate 1iquidity.‘ The supply of equity-financed capital is small, among other reasons, because the number of securi- ties offered is small; however, the demand for equity-financed capital is small partly because of the small number of savers willing and able to buy securities. In other terms, the supply of negotiable securities is small because there is a weak demand for them; but the demand is weak because there are so few securities offered in the market. In summary, most of the stock exchanges in Latin America have the following characteristics: 1. The volume of transactions has been low for most of the exchanges as measured by the ratio of total transactions to gross domestic product. 2. Fixed-income securities such as bonds are traded rather than shares of stock. 3. The supply of negotiable securities or the number of businesses willing to sell their stock has been relatively small. 154 4. The number of securities actually traded on a regular basis is, in most cases, much smaller than the number of securities listed on the exchange.16 5. Stock price index movements have been unstable and susceptible to inflationary pressures. In real terms, stock price indices have fallen on the average since 1959. 6. Inadequate liquidity exists for many of the secondary markets. Elements of a Successful Stock Market The characteristics of Latin American stock ex- changes and the analysis of factors affecting the supply of and demand for equity-financed capital in Panama suggest that a successful stock market requires a number of basic elements.17 First, a stock market requires a large number of firms with a demand for long-term capital that is greater than that provided by existing financial institutions such as commercial banks. In general, only industrial firms and public utilities will encounter such capital demands as they expand the size of their plant and equipment. Second, these industrial firms must be willing to share ownership and some decision-making power that previously resided with a small group. Third, the firms should be profitable enough to offer an attractive rate of return to savers in the form of dividend payments and a rising stock price in the long-run. Fourth, the number of savers must be large, so as to provide the funds required by investors and to 155 prevent a concentration of ownership in the industrial firms. A high concentration of ownership by a few savers can lead to monopoly power in commodity markets and price manipulation in the stock markets. Fifth, savers must understand the principles behind the buying and selling of securities. Savers should understand, for example, how stock prices fluctuate in response to changes in economic variables such as political stability. Sixth, there must be liquidity in the secondary market. Savers must be able to sell their shares whenever they desire. To provide liquidity, traders and/or market-making institutions should be present in the marketplace. Traders are individuals who buy and sell securities regularly. They buy or sell securities on the basis of speculation where the current market price of the security does not accurately reflect the future profitability of the company. A market-making financial institution such as a development bank may also provide liquidity by explicitly guaranteeing that the redemption of securities will be possible on reasonable terms in the event of a crisis. Lastly, a successful stock market requires a regulatory framework that will prevent fraudulent dealings, protect the rights of minority stockholders and establish standards for the reporting of financial data by the business firms issuing stock. 156 Guidelines for Economic Growth and Development Orthodox growth theory argues that capital markets are necessary for prolonged economic growth. As the capital requirements of a business firm go beyond the limits of self-finance, capital markets are needed to provide addi- tional funds to the firm so that it can expand the size of its operation. These additional funds could be acquired by issuing capital stock or debt, i.e. by selling shares of stock to the public or borrowing from a bank. According to growth theory, these additional funds will be used to purchase new capital goods which increases the capacity to produce goods and services.18 While it is true that the capital requirements of firms may go beyond the limits of self-finance during the process of economic growth, it is not necessarily true that stock markets are the best means of supplying the additional capital funds. As this dissertation has suggested, when the business sector is characterized by commercial and service-oriented enterprises, the demand for capital funds may be better satisfied with short-term capital debt rather than long-term equity-financed capital. On the other hand, if the business sector is characterized by a growing number of industrial or manufacturing firms with a demand for equity-financed capital, then stock markets can be expected to enhance the mobilization of financial resources. 157 If the economic goals of an economy include the reduction of poverty and the unequal distribution of income, it is doubtful that stock markets will positively affect such goals. The poverty-stricken members of the economy would be virtually unable to purchase securities and, hence, any benefits provided by a stock market would not accrue to them. Even if large numbers of individuals from all income levels were buying and selling stock, it is unlikely that the profits of such activities would automatically flow from the upper—income groups to the lower-income groups. More than likely, the trading activity would be concentrated among the wealthy, and income would only be redistributed within that group of individuals. This would be particularly true in Panama where virtually all of the savings are accounted for by business firms and foreign depositors. Hence, stock markets cannot be expected materially to affect the problem of income and wealth inequality, and unless an industrial base is established, these markets may not effectively mobilize resources for economic growth. In terms of guidelines for economic growth, capital debt markets should be established when the demand for capital funds goes beyond the limits of self-finance. Stock markets should only be established when the process of industrialization has reached a stage where the demand for equity-financed capital is quite evident and the risk of business failure is minimal. In 158 the early stages of industrialization, the risk of business failure may be high. As a result, businessmen may prefer equity-financed capital to debt capital, since there is no financial obligation associated with the former source of capital funds. But if the risk of failure is high, savers will be most reluctant to supply the capital funds. There- fore, stock markets may not effectively supply the required funds. FOOTNOTES--CHAPTER V 1Raymond W. Goldsmith, "The Mobilization of Domestic Resources for Economic Growth Through the Financial System," in The Mobilization of Internal Financial Resources in Latin America, Inter-American Development Bank (Lima: Inter-American Development Bank, 1971), p. 3. 2 Ibid., p. 18. 3A money illusion occurs if a doubling of all prices and wages leads to an increase in consumption, even though real income remains unchanged. The money illusion implies that consumers and savers change their consumption and saving patterns in response to changes in nominal income rather than real income. 4In macroeconomic theory, the market rate of interest is the interest rate at which the real and money interest rates are equal. The money interest rate is defined as that rate that equates the demand for money and the supply of money, while the real interest rate equates intended saving and investment. Thus, interest rates offered to bondholders were "equilibrium" rates for both government and private issuers. The demand and supply factors just balanced at the rates offered to bondholders. 5Goldsmith, ”Mobilization of Domestic Resources," p. 18. An eight factor may be that Anglo-Saxon commercial law was favorable to the development of securities markets. Spanish law, however, was derived from Napoleonic law which was not as favorable to such markets. 61bid., p. 19. 7Antonin Basch and Milic Kybal, Capital Markets in Latin America: A General Survgy and Six Country Studies (New York: Praeger Publishers,—l97l), p. 66. 81bid. 9Economic Commission for Latin America, The Process of Industrial Development in Latin America (New York: United Nations, 1966), p. 205. 159 160 101212: 11313151,, p. 210. 73 12Antonin Basch and Milic Kybal, Capital Markets, p. . 13M., p. 75. 14Ibid. ISM” p. 77. 16 On the New York Stock Exchange, virtually all listed securities are traded on a daily basis. On the over-the-counter markets, there is a low number of securi- ties that are not traded on a daily basis. 17A successful stock market can be defined as one that: (1) continually mobilizes capital funds for economic growth and chanels them to businesses in need of funds; and (2) provides liquidity in a secondary market. 18Charles P. Kindleberger, Economic Development (New York: McGraw-Hill Book Company, Inc., 1958), p. 42. CHAPTER VI SUMMARY AND CONCLUSIONS The purpose of this study has been to inquire into whether the establishment of an organized stock market would enhance the economic and financial development of Panama. It was hypothesized that Panama should establish an organized stock market at its present stage of economic development because : (1) there is a need for equity- financed capital on the part of Panamanian business firms; (2) there are many financial institutions willing and able to act as financial intermediaries; (3) there is an ever- increasing supply of savings that can be expected to flow into business firms through the sale of stock; and (4) a stock market will promote economic development by in- creasing the capacity to produce goods and services. Given the evidence presented here, this hypothesis must be rejected for a number of reasons. First, only a few Panamanian businesses have a demand for equity—financed capital. The business sector in Panama is characterized by a relatively large number of commercial and service-oriented enterprises. These firms need capital funds primarily to finance inventories and accounts receivable. These capital needs are 161 162 unpredictable and occur frequently since they are affected by price fluctuations on international markets and changes in supply factors abroad. This sporadic demand for capital is better satisfied by a source of short-term capital funds such as that provided by an overdraft mechanism rather than by the issuance of capital stock. The financial data collected from 255 business firms indicated that the firms were able to raise capital through the issuance of stock, but were unwilling to do so. The businesses seem to prefer debt capital since it better suits their capital needs, is easily obtainable, and does not entail the sharing of ownership. Second, although there are many financial insti- tutions in Panama capable of buying corporate securities, they are generally unwilling to do so. The many commercial banks in Panama are not operating to enhance the economic development of Panama by buying the securities of Panamanian businesses. Banks operate in Panama because it is relatively profitable to undertake business there. The liberal tax laws, the U. S. dollar standard, and the absence of exchange controls and a central bank are conducive to profitable banking activity. In the past, neither commercial banks nor non-monetary financial institutions have purchased primary securities from.local enterprises to any appreciable extent. The reasons for this are: (1) very few local enterprises have offered securities for sale, and (2) the 163 rate of return on those securities that were offered was low relative to other forms of savings. Third, although the level of savings in Panama is growing rapidly in terms of bank deposits, most of the deposits are from foreign sources. Also, the largest proportion of domestic savings is derived from corporations in Panama, not from individuals. With such a distribution of savings, it is unlikely that the supply of savings would be channeled into corporate securities as it was in Europe and North America prior to World War I. In addition, the rate of return on alternative forms of savings have been historically higher than the return on corporate securities. Fourth, stock markets cannot be expected to promote economic development in Panama. As discussed earlier, such markets may not appreciably affect the problems of poverty, unemployment or the distribution of income in a positive way. Stock markets could stimulate economic growth by providing long-term capital for investments if there existed a strong demand for equity-financed capital or if the process of industrialization was well established. The data presented in this study, however, indicate that a strong demand for equity-financed capital does not exist for most Panamanian businesses and the economy has not become indus- trialized. Furthermore, the analysis of Panama's economic characteristics suggests that it may not be prudent to 164 pursue the course of industrialization. A relatively small labor force, higher wages than other Latin American countries, the lack of abundant natural resources, the limited domestic market, and the existing labor code are not conducive to the establishment of industrial firms. Panama's real comparative advantages are the liberal tax and corporate laws, the absence of exchange controls and a central bank, the fact that the U. S. dollar is the standard currency, and its geographic position. The economic problems are centered around poverty, inflation, unemployment, and an unequal distribution of income and wealth. Stock markets cannot be expected to either enhance the comparative advan- tages of Panama or to solve its basic economic problems. APPENDICES 165 APPENDIX A 166 167 oam.a moa. oom.a mac.o aco. oom.a oo noono< annoy ou moaow uoz mo oaumm mom. om~. ma~.~ oo.oa o one. co oaooua any nobo< caoa nooooa>ac o6 oaoom Hom.oo \o oma.om \o onc.oom \o ooo.ooa.~ \o o \o oam.aoa \o co oaoa nooooa>ao moo. mac. oNa. one. ooc. oaa. co norms uooo< ooaom uoz co cusumm mo comm oua. omc. oNN. ~a~.a o How. co roe uoao< moaoom co cusuom mo oumm Noa. Nac. oaa. Non. ooc. oma. oo noxoa aooo< aooaooo co fluflumx MO mumm Noo.ooa \o coo.o~ \o moo.ao~ \o aom.ma~.N \o moo.mo \o occ.om~ \o ao roe pooo< oauoua ooz ca. oao. ooa. oNo. oao. mom. om norms opoooo aooaaoo CO Gusuwm NO wumm on. maa. mom.a n.m o oN~.a oo abaoom Ou mama mo Oaumm aao.c- \o mao.mao \o Hoo.oam.o\o coo.ao~.~o\o mao.am \o aao.mom.m\o oo aooc annoy on. mac. omm. a c Nam. co aoaooo on awaaopom tweamuom mo oaumm coo.~ok \o ac~.oom \o oma.mco.m\o mMN.aoo.~N\o c \o mom.oom.a\o co aoaoom pooaorxooom ooa.mxm \o oam.o- \o oma.oaa.m\o cam.oao.oa\o Aaca.coc\o NNN.omo \o co owoaouom oooaooor aoo.oo~ \o ooo.aa~ \o ooa.ooo.m\o oao.xoo.oa\o c \o oa~.oao \o co aooaaoo :Haoaoa can. oNo. omm. coo. o Non. oo noonna aoooe oo nooona ooxaa ooz co oaooa oco.oom \o ooa.oco \o moo.o~m.k\o coo.~am.oo\o c \o HAN.oNo.~\o oo nooon< ooxan ooz Hoooa ~a~.moo.a\o oa~.ooo.a\o oom.com.o\o omm.oao.oo\o oma.mcm\o awm.ac~.a\o om nooonr annoy oo~.ooo.m\o moo.moo \o moo.~am.o\o oco.aoc.m~\o mao.oa~\o amo.ooo.M\o oo noaom aoz Hobos oxo.oa~ \o ooo.oo \o moo.com \o mma.omm.o \o moa.oaa\o mmo.oom \o ooa oaoooa oaooroe aoz floater coo: wo GOauma>oo moam> osam> coo: m:0aum>homno nouum pumvcwum pumpcmum assaCaz pounwaoBc: mo pmnasz EDEaxmz .ONma .mEuam amaucmCamlcoz umwwuma 00a Eouw mama amaocmCam mo muw683m amoaumaumum o>aumauumooll.a.< mqmmQ madame» mad—war Cam: MCOHum>HmmnO uouum vumpcmum unaccoum aoeaxmz asaacaz wounwaoac: mo Honasz .ammaamoma .mauam amaocmcamscoz pouooammlmaEOpcmx mma Scum mama amaocmcam mo mumEESm amoaumaumum o>aumauomoolu.a.m mamua usam> usam> coo: mcoaum>uumno uouum vuuocmum pumpcmum aaaaxmz aneacaz moonwaoac: mo nonasz .vwscaucoual.a.m mam<9 171 cmo.o omo.x amo.co occ.~om Acoa.c ooa.a~ co aaoa ooo.o ~a~.o oo~.oo mmo.aa~ coo. aam.a~ as caca aoo.ca omo.ma moo.mma ~oa.oco mac. aco.mo ac coca vacuum umououca mmaah c oa.oom.m \o mao.oo \c oom.co~ \o o \c oam.aa \o mma aaca HNM\o o~.~a~.~ \o aoo.o~ \o oo~.aam \o c \o coo.o \o moa oxca ocN\o ~a.ooo.a \o coo.aa \o aoo.ama \o o \o oo~.o \o Noa coca umcmmxm umououcH coo.a mow. aNN.~ Ham.ma aoo. mao.a oaa aaoa oac.a “ma. Noo.a c~.oa coo. mao.a coa caca oaa.a moo. mam.m moo.oo ch. coo.a mma coca muwmw< HmuOH Ou wmamm umz mo oaumm c coo. moc.a ooa.oa Acam.cmc acc. ama amoa c coo. cmo.a NNo.a c coo. caa okoa o Koo. Boo. acm.m c mam. aaa coca oaoopa roe aoaoa on oaoa nooooa>ao oo oaoor c \o oam.omo.m \o mNo.co \o rom.mam \o o \o nxc.ma \o oma akca o \o cam.aco.o \o aaa.mm \c coc.moo \o c \o oNN.oa \o coa oaoa c \o moo.ooo.a \o omo.aa \o amc.aca \o o \o coa.n \o ooa coca oaoa nonooa>ao mac. amo. mam. Nao. Aao.ac Naa. ama aaoa ooa. oac. coa. moo. AmoN.c oma. moa omoa mca. oac. qua. can. Amcc.c caa. Noa coca mmamm uoz Ou xoh wouw< oaooua uoz mo oaoom Gwafiwz 6mm: MO COHuMfl>mQ w=Hm> mDHm> 3mm: mCOwum>HmeO nonum Upmpcoum pumpCMum Essaxmz Essacaz pounwam353 wo umnsnz .pmscaucoucl.a.m mam<9 APPENDIX C 172 CUESTIONARIO Producto Principal de la Cia. Hace cuafitos afios opera: A. 1-5 afios B. 6-10 afios C. 10-15 afios D. mas de 15 afios Es esta Cia: A. Propiedad y Controlada pro ciudadanos panamefios B. Subsidiaria de una Cia. extranjera C. Propiedad y Controlada pro panamefios y extranjeros no residentes D. Otra. Si la No. 3 contesté (C), conteste la pregunta No. 4, si no fué (C), siga con la pregunta No. 5 Quién domina con propiedad y control: A. Panamefios B. Extranjeros no residentes Es 1a Compania: A. Propiedad familiar o Cia. cerrada B. Propiedad abierta donde la mayoria de los accionistas no son empleados de la misma o famillares de los miembros de la directiva. , C. Propiedad abierta donde 1a mayoria de los accionistas son empleados de la misma o familiares de 1os miembros de la directiva. Durante los dos (2) filtimos periodos fiscales, obtuvo la Cia., capital adicional para sus operaciones. A. Si B. No Si 1a respuesta a la pregunta anterior fué afirmative, como se obtuvo e1 capital adicional. A. Deuda a corto plazo B. Dueda a largo plazo C. Emisién de acciones 173 10. ll. 12. 13. 174 D. Mediante fuentes internas. (Retencién de Utilidades u otras reservas) E. Otro. Si 1a respuesta a la pregunta anterior fué (A), conteste la pregunta No. 8, si no fue (A), siga a la pregunta No. 9. En realidad qué procentaje de préstamos a corto plazo eren de largo plazo. Cuéles fueron los usos especificos del incremento de capital: A. Expansién de planta o facilidades de produccién B. Aumentos de Inventarios C. Aumento de Créditos a clientes D. Otro. En los filtimos dos (2) afios la Cia. ha vendido valores? A. Si B. No Si la respuesta anterior fué afirmativa, qué clase de valores se vendian: A. Acciones Comunes B. Acciones Preferidas C. Bonos D. Otros A quiénes se vendieron los valcres: A. Directores, ejecutivos o empleados de la empresa B Parientes y amigos C A otras Compafiias D. A un banco o bancos E A1 publico en general Durante los proximos tres (3) afios, ademés de la depreciancién y superavit ganado, necesitaré su compafiia fuentes adicionales de 1as que se pueden conseguir capital para costear nueovos activos fisicos y/o capital en giro permanente. A. Si B. No 14. 15. l6. 17. 175 Si usted pudiera escoger, como preferiria financiar 1a empresa. A. Pidiendo a Instituciones financieras B. Vendiendo valores (Bonos o acciones) pfiblica o privademente. Aproximadamente, cuéntos accionistas tiene la empresa? A 1-10 B. 11-25 C. 26-50 D 51-100 E Mas de 100 Ha tenido alguna vex la compania que usted representa, algfin proyecto o expansién que no pudo financiarse pro las Instituciones financieras existentes en Panama: A. Si B. No Cuél es su status en la Cia.: A. Presidente B Director C. Generente o Administrador General D Otro APPENDIX D 176 CLASSIFICATION OF COMPANIES SURVEYED BY QUESTIONNAIRE, 1972 DATA Classification Industrial—Manufacturing Retail-Commercial Construction Transportation TOTAL Questionnaire Results 31> o. Ans. 177 Frequengy 18 28 3 1 50 Number 4-\\O LDNH MN ”1 w l OH-L‘J—‘J—‘V 0 MN UMP UH—‘b clam 61 I (DJ-‘0‘ CONE—'0.) 0 do .—- «L‘OO‘WOKO Percent 36.0 56.0 6.0 2.0 100.0 Percent 18.0 8.0 24.0 50.0 a 10. ll. 12. 13. 14. 15. 16. 17. No Cd? ZUOUUI> ZUOtxH> w3> ZUH> ZMUPF’? s> mess? U0w> Response. . Ans. . Ans. . Ans. . Ans. 178 I" bU‘lmNKO UJH U1N mo mlb .4 N a. a ml mo ml... is]... .4 cl | ommoo ODO‘ Nl-‘J-‘U'ICD OOH ONNO‘ COO-POHl-‘Ch GOOD—“OH OCDN (I) \l H ChCDONNN CO 000 H L‘U'l O p-L‘N O .—I FWD 0 GOO 000 O HUI O abNmOO‘ 00000 N BIBLIOGRAPHY 179 BIBLIOGRAPHY Andres de Oteyza, José. Politicas de Fomento de los Mercados de Capitales. Mexico: Centro De Estudios Monetarios Latino-americanos, 1971. Asociacién Venezolana de Ejecutivos, Mercado De Capitales. Caracas, Venezolana: Asociacion Venezolana De Ejecutivos, 1971. Basch, Antonin and Kybal, Milic, Capital Markets in Latin America: A General Survey and Six Country Studies. 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