【正文】 n that internal ?nance is by far the most important source of funds in all ?nance is moderately important in most countries and particularly important in Japan and France. Bond ?nance is only important in the US and equity ?nance is either unimportant or negative (., shares are being repurchased in aggregate) in all countries. Mayer’s studies and those using his methodology have had an important impact because they have raised the question of how important ?nancial markets are in terms of providing funds for investment. It seems that, at least in the aggregate, equity markets are unimportant while bond markets are important only in the US. These ?ndings contrast strongly with the emphasis on equity and bond markets in the traditional ?nance literature. Bank ?nance is important in all countries,but not as important as internal ?nance. Another perspective on how the ?nancial system operates is obtained by looking at savings and the holding of ?nancial assets. Table 3 shows the relative importance of banks and markets in the US, UK, Japan, France and Germany. It can be seen that the US is at one extreme and Germany at the other. In the US, banks are relatively unimportant: the ratio of assets to GDP is only 53%, about a third the German ratio of 152%. On the other hand, the US ratio of equity market capitalization to GDP is 82%, three times the German ratio of 24%. Japan and the UK are interesting intermediate cases where banks and markets are both important. In France, banks are important and markets less so. The US and UK are often referred to as marketbased systems while Germany, Japan and France are often referred to as bankbased systems. Table 4 shows the total portfolio allocation of assets ultimately owned by the household sector. In the US and UK, equity is a much more important ponent of household assets than in Japan,Germany and France. For cash and cash equivalents (which includes bank accounts), the reverse is true. Tables 3 and 4 provide an interesting contrast to Table 2. One would expect that, in the long run, household portfolios would re?ect the ?nancing patterns of ?rms. Since internal ?nance accrues to equity holders, one might expect that equity would be much more important in Japan, France and Germany. There are, of course, di?erences in the data sets underlying the di?erent tables. For example, household portfolios consist of ?nancial assets and exclude privately held ?rms, whereas the sourcesandusesoffunds data include all ?rms. Nevertheless, it seems unlikely that these di?erences could cause such huge discrepancies. It is puzzling that these di?erent ways of viewing the ?nancial system produce such radically di?erent results. Another puzzle concerning internal versus external ?nance is the di?erence between the developed world and emerging countries. Although it is true for the US, UK, Japan, France, Germany and for most other developed countries that internal ?nance dominates external ?nance, this is not the case for emerging countries. Singh and Hamid (1992) and Singh (1995) show that, for a range of emerging economies, external ?nance is more important than internal ?nance. Moreover, equity is the most important ?nancing instrument and dominates debt. This di?erence between the industrialized nations and the emerging countries has so far received little attention. There is a large theoretical literature on the operation of and rationale for internal capital markets. Internal capital markets di?er from external capital markets because of asymmetric information, investment incentives, asset speci?city, control rights, transaction costs or inplete markets There has also been considerable debate on the relationship between liquidity and investment (see, for example, Fazzari, Hubbard and Petersen(1988), Hoshi, Kashyap and Scharfstein (1991))that the lender will not carry out the threat in practice, the incentive e?ect disappears. Although the lender’s behavior is now ex post optimal, both parties may be worse o? ex ante. The time inconsistency of mitments that are optimal ex ante and suboptimal ex post is typical in contracting problems. The contract mits one to certain courses