Financing Development: The Role of Information Costs
Jeremy Greenwood, Juan M. Sanchez, Cheng Wang
American Economic Review · 2010 · Volume 100 · Issue 4
Abstract
To address how technological progress in financial intermediation affects the economy, a costly-state verification framework is embedded into the standard growth model. The framework has two novel ingredients. First, firms differ in the risk/return combinations that they offer. Second, the efficacy of monitoring depends upon the amount of resources invested in the activity. A financial theory of firm size results. Undeserving firms are over-financed, deserving ones under-funded. Technological advance in intermediation leads to more capital accumulation and a redirection of funds away from unproductive firms toward productive ones. With continued progress, the economy approaches its first-best equilibrium. (JEL G21, G31, O16, O33, O41)
Keywords
Banks, Other Depository Institutions, Micro Finance Institutions, Mortgages, Capital Budgeting, Fixed Investment and Inventory Studies, Capacity, Economic Development: Financial Markets, Saving and Capital Investment, Corporate Finance and Governance, Technological Change: Choices and Consequences, Diffusion Processes, One, Two, and Multisector Growth Models
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