The use of equity finance by development finance institutions in Malawi.
The main purpose of the thesis is to investigate one possible reason for
the poor performance of Development Finance Institutions, and consequently
to identify one possible way in which future performance might be improved.
Financial Institutions can choose from two main investment instruments: loan
and equity. Most DFIs have chosen to use loans almost exclusively. However,
equity funding has a number of potential advantages over loans. One such
advantage is equity's ability to compensate for risk, thus allowing a DFI to
invest in higher risk projects which have the potential for higher returns.
The research considers two DFIs in Malawi, both of which invest loan and
equity finance. Five hypotheses are used to test whether equity's potential
advantages have been of practical benefit. Each of these hypotheses is
summarised below, followed by the result of the research.
i Equity financed projects are more fully funded than are loan financed
projects: not supported.
ii The servicing cost of equity finance is more flexible, but the overall
returns to equity are higher for the DFI: only the second part
iii Further funding is more likely to be provided in equity cases: only
iv Some investments can only be financially justified by using equity: not
v More management help is given by the DFI in the case of equity
A sixth hypothesis considers whether other factors, such as project
appraisal methodology, external political pressure and internal operating
procedures may have outweighed financial considerations such as the choice
between equity and loan finance. (If so, then the potential advantages of
equity would not have resulted in much practical benefit. ) There is
evidence, although it is not conclusive, to support this hypothesis.
The thesis concludes that the DFIs examined have hardly used the potential
advantages of equity. The likeliest explanation for this appears to be that
decisions on whether or not to use equity finance were dominated by the
other factors identified in the sixth hypothesis.