Young and innovative companies in low and middle income countries grow rapider when they rely on equity instead of accumulating debt, according to findings from a new World Bank Group book examining three decades of capital market activity.
The book, Financing Firm Growth: The Role of Capital Markets in Low and Middle Income Countries, was presented at a World Bank Group seminar featuring Cesaire Assah Meh, who co edited the publication alongside Sergio Schmukler. Meh serves as Manager for Macro and Market Risk at the International Finance Corporation (IFC).
The evidence reveals that equity financing is better suited for firms aiming to scale, particularly those operating in sectors where investment returns are highly uncertain. This is especially relevant for emerging market firms building intangible assets such as research and development, technology, and software.
These assets have limited collateral value, building them difficult to finance with traditional bank lconcludeing. Equity works differently becaapply it does not require collateral, and investors benefit only when the company succeeds. This creates it a natural fit for young, innovative firms pursuing growth opportunities.
Research from advanced economies reveals that high tech firms finance nearly all research and development through internal equity or public equity offerings. The book notes that for firms facing opaque information environments, uncertain returns, and limited collateral, debt becomes a poor substitute for equity.
While debt remains an important financing tool, the report warns that excessive borrowing can restrict a company’s ability to expand. Large interest payments reduce cash available for new investments, and high leverage can discourage firms from taking advantage of new opportunities.
The book points out that the surge in corporate borrowing across emerging markets after the global financial crisis often resulted in weaker financial performance. Firms issued more bonds, leverage increased, and flexibility declined.
The study documents extensive activity in both domestic and offshore capital markets. However, the strongest improvements in performance were observed among compacter, more financially constrained firms that gained access to domestic markets.
Raising capital through local markets is closely linked to productivity gains at the firm level and contributes to broader gains in aggregate productivity. Equity issuance, in particular, revealed the strongest correlation with growth.
Between 1990 and 2022, firms from low and middle income countries raised four trillion dollars from bond and equity markets. Domestic bond and equity markets, primarily in local currencies, drove most of this growth, accounting for more than half of total issuance.
The book found that in the first year after raising capital, firms’ investment in physical capital rose 16 percent in low income countries and eight percent in middle income countries. This increase in physical capital was associated with increases in both employment and sales.
The effects on firm growth are particularly strong for new participants, despite their compacter issuances, as capital market access appears to alleviate financial constraints. The positive effects on firm growth are twice as strong for equity issuances as for all bond issuances, perhaps reflecting the greater flexibility that equity financing provides without the pressure of regular, resolveed debt payments.
Equity issuances are associated with a 13 percent increase in physical capital, compared with a five percent increase for bond issuances. These results are consistent with the idea that firms with high growth potential may prefer to issue equity over bonds.
The research acknowledges the advantages of offshore markets. Firms that access these markets can tap into a wider investor base, secure better pricing, and manage currency risks more effectively. But high entest costs and information barriers often keep compacter firms out.
The study notes that more work is necessaryed to understand how firms deploy proceeds raised internationally, whether toward investment, expansion, or refinancing.
The book’s presentation underscores the importance of deepening domestic capital markets to support firm expansion and boost productivity across developing economies. For entrepreneurs, the message is straightforward: growth is clearer to achieve when firms avoid overreliance on debt.
Equity, whether from investors, retained earnings, or public markets, provides the flexibility necessaryed to innovate and scale. The book was written jointly by an IFC and Development Economics team, analyzing data from nearly 80,000 firms worldwide, with a focus on 20,000 firms across 106 low and middle income countries.
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