Abstract

Volume of Investment and Risk Allocation

It is argued in the course of the equity capital gap discussion that equity capital, where insufficient in amount, impedes investment in risky ventures. This contribution, however, emphasizes not so much the adequacy of amount, but the risk allocation associated with equity capital investment. Where the amount of equity is very large, but the allocation of risks is poor, the risk premium may become so great that the net value of the investment turns negative. In such cases, an investment does not fail over inadequate equity capitalization, but over an inappropriate exploitation of the capital market's willingness to accept risks. It is demonstrated on the basis of a simple model that, in the light of this consideration, the spreading of risks in the form of equity financing has a positive effect on investment acitivity. From that angle, the promotion of equity financing is helpful in the stimulation of risky investments. Where drawbacks of external equity financing are taken into consideration, which result especially from an asymmetrical spread of information, the positive evaluation is overcast by an element of relativity. The model variants as presented here suggest an impairment of just the advantages of equity financing; however, the inclusion of further drawbacks may also mean that equity financing is rejected altogether.