Investment in Relationship-Specific Assets: Does Finance Matter?

Abstract

Banks (but not stock markets) promote economic growth by facilitating relationship-specific investment between buyers and suppliers of intermediate goods. Combined insights from literature on signaling role of banks and on relationship-specific investment motivate this economic channel: A supplier is reluctant to undertake relationship-specific investment as she cannot observe financial stability and planning horizon of buyer. Banks can mitigate this information asymmetry. Empirical results from twenty-eight industries in ninety countries confirm that industries dependent on relationship-specific investment from their suppliers grow disproportionately faster in countries with a well-developed banking sector. The channel works via increased entry of new firms and higher capital accumulation.