Investment in Segmented Capital Markets

Bankers' screening devices are identified to determine firms' probability of borrowing in the 'formal' segment of the capital market in Pakistan. Incorporating this information, investment functions are estimated using a two stage switching regressions model with endogenous switching. It is concluded that firms that borrow in the 'formal' markets behave according to the flexible accelerator model of investment while non-borrowing firms plough back profits. Furthermore, the former have higher capital-output ratios and find it less difficult to adjust to their desired capital stocks compared to the latter. Investment determinants related to entrepreneurial and firm features are also identified.