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American Economic Review Vol. 100 No. 4 2010

Financing Development: The Role of Information Costs

Jeremy Greenwood1; Juan M. Sánchez2; Cheng Wang3

1 Department of Economics, McNeil Blg. 160, University of Pennsylvania, Philadelphia, PA 19104-6297. · 2 Research Department, The Federal Reserve Bank of Richmond, 701 East Byrd Street, 22nd Floor, Richmond, VA 23261, and Federal Reserve Bank of St. Louis. · 3 School of Economics, Fudan University, Shanghai, China 200433 and Department of Economics, Iowa State University, Ames, IA 50011.

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.

DOI
10.1257/aer.100.4.1875
Volume
100
Issue
4
Pages
1875-1891
Language
en
Sources
openalex crossref bibtex:phds-export.bib

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