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Financing Development: The Role of Information Costs

  • Jeremy Greenwood
  • Juan M. Sanchez
  • Cheng Wang

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)

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 100 (2010)
Issue (Month): 4 (September)
Pages: 1875-91

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Handle: RePEc:aea:aecrev:v:100:y:2010:i:4:p:1875-91
Note: DOI: 10.1257/aer.100.4.1875
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