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. Quantitative analysis suggests that finance is important for growth.
CITATION STYLE
Greenwood, J., Sanchez, J. M., & Wang, C. (2011). Financing Development: The Role of Information Costs. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.996263
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