IDEAS home Printed from
MyIDEAS: Login to save this article or follow this journal

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)

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: no

File URL:
Download Restriction: Access to full text is restricted to AEA members and institutional subscribers.

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

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

in new window

Handle: RePEc:aea:aecrev:v:100:y:2010:i:4:p:1875-91
Note: DOI: 10.1257/aer.100.4.1875
Contact details of provider: Web page:

More information through EDIRC

Order Information: Web:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Stephen D. Williamson, 1984. "Costly Monitoring, Financial Intermediation, and Equilibrium Credit Rationing," Working Papers 583, Queen's University, Department of Economics.
  2. Shankha Chakraborty & Amartya Lahiri, 2003. "Costly Intermediation and the Poverty of Nations," University of Oregon Economics Department Working Papers 2003-1, University of Oregon Economics Department, revised 01 Jan 2003.
  3. Foster, Lucia & Haltiwanger, John C. & Syverson, Chad, 2005. "Reallocation, Firm Turnover, and Efficiency: Selection on Productivity or Profitability?," IZA Discussion Papers 1705, Institute for the Study of Labor (IZA).
  4. Albert Marcet & Ramon Marimon, 1992. "Communication, commitment, and growth," Discussion Paper / Institute for Empirical Macroeconomics 74, Federal Reserve Bank of Minneapolis.
  5. Francisco J. Buera & Joseph Kaboski & Yongseok Shin, 2009. "Finance and Development: A Tale of Two Sectors," NBER Working Papers 14914, National Bureau of Economic Research, Inc.
  6. Gian Luca Clementi & Hugo Hopenhagn, 2004. "A Theory of Financing Constraints and Firm Dynamics," Working Papers 04-25, New York University, Leonard N. Stern School of Business, Department of Economics.
  7. Paul Harrison & Oren Sussman & Joseph Zeira, 1999. "Finance and growth: theory and new evidence," Finance and Economics Discussion Series 1999-35, Board of Governors of the Federal Reserve System (U.S.).
  8. Beck, Thorsten & Demirguc-Kunt, Asli & Levine, Ross, 1999. "A new database on financial development and structure," Policy Research Working Paper Series 2146, The World Bank.
  9. Richard Rogerson & Diego Restuccia, 2004. "Policy Distortions and Aggregate Productivity with Heterogeneous Plants," 2004 Meeting Papers 69, Society for Economic Dynamics.
  10. Boyd, John H. & Prescott, Edward C., 1986. "Financial intermediary-coalitions," Journal of Economic Theory, Elsevier, vol. 38(2), pages 211-232, April.
  11. Levine, Ross, 2005. "Finance and Growth: Theory and Evidence," Handbook of Economic Growth, in: Philippe Aghion & Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 12, pages 865-934 Elsevier.
  12. Robert M. Townsend & Kenichi Ueda, 2003. "Financial Deepening, Inequality, and Growth: A Model-Based Quantitative Evaluation," IMF Working Papers 03/193, International Monetary Fund.
  13. Rui Castro & Gian Luca Clementi & Glenn Macdonald, 2009. "Legal Institutions, Sectoral Heterogeneity, and Economic Development," Review of Economic Studies, Oxford University Press, vol. 76(2), pages 529-561.
  14. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  15. Gertler, Mark, 1992. "Financial Capacity and Output Fluctuations in an Economy with Multi-period Financial Relationships," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 455-72, July.
  16. Bart Hobijn & Boyan Jovanovic, 2001. "The Information-Technology Revolution and the Stock Market: Evidence," American Economic Review, American Economic Association, vol. 91(5), pages 1203-1220, December.
  17. Carol Corrado & Charles Hulten & Daniel Sichel, 2006. "Intangible capital and economic growth," Finance and Economics Discussion Series 2006-24, Board of Governors of the Federal Reserve System (U.S.).
  18. Greenwood, Jeremy & Jovanovic, Boyan, 1988. "Financial Development, Growth, And The Distribution Of Income," Working Papers 88-12, C.V. Starr Center for Applied Economics, New York University.
  19. Jeremy Greenwood & Juan M. Sánchez & Cheng Wang, 2010. "Financing development: the role of information costs," Working Papers 2010-024, Federal Reserve Bank of St. Louis.
  20. Rui Castro & Gian Luca Clementi & Glenn MacDonald, 2004. "Investor Protection, Optimal Incentives, and Economic Growth," The Quarterly Journal of Economics, MIT Press, vol. 119(3), pages 1131-1175, August.
  21. Cheng Wang, 2005. "Dynamic costly state verification," Economic Theory, Springer, vol. 25(4), pages 887-916, 06.
  22. Andres Erosa & Ana Hidalgo, 2005. "On Capital Market Imperfections as a Source of Low TFP and Economic Rents," Working Papers tecipa-200, University of Toronto, Department of Economics.
  23. Quadrini, Vincenzo, 2004. "Investment and liquidation in renegotiation-proof contracts with moral hazard," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 713-751, May.
  24. Bencivenga, Valerie R & Smith, Bruce D, 1991. "Financial Intermediation and Endogenous Growth," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 195-209, April.
  25. Stephen L. Parente & Edward C. Prescott, 2002. "Barriers to Riches," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262661306, June.
  26. Berger, Allen N, 2003. " The Economic Effects of Technological Progress: Evidence from the Banking Industry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(2), pages 141-76, April.
  27. Thomas F. Cooley & Vincenzo Quadrini, 1999. "Financial Markets and Firm Dynamics," Working Papers 99-14, New York University, Leonard N. Stern School of Business, Department of Economics.
  28. Rousseau, Peter L., 1998. "The permanent effects of innovation on financial depth:: Theory and US historical evidence from unobservable components models," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 387-425, July.
  29. Levine, Ross, 1991. " Stock Markets, Growth, and Tax Policy," Journal of Finance, American Finance Association, vol. 46(4), pages 1445-65, September.
  30. Ellen R. McGrattan & Edward C. Prescott, 2005. "Taxes, Regulations, and the Value of U.S. and U.K. Corporations," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 767-796.
  31. Smith, A. A. & Wang, Cheng, 2006. "Dynamic Credit Relationships in General Equilibrium," Staff General Research Papers 12263, Iowa State University, Department of Economics.
  32. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December.
  33. Williamson, Stephen D, 1987. "Financial Intermediation, Business Failures, and Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1196-1216, December.
  34. Khan, Aubhik, 2001. "Financial Development And Economic Growth," Macroeconomic Dynamics, Cambridge University Press, vol. 5(03), pages 413-433, June.
  35. Li, Wenli & Sarte, Pierre-Daniel G., 2003. "Credit market frictions and their direct effects on U.S. manufacturing fluctuations," Journal of Economic Dynamics and Control, Elsevier, vol. 28(3), pages 419-443, December.
  36. repec:cup:macdyn:v:5:y:2001:i:3:p:413-33 is not listed on IDEAS
  37. Andrés Erosa & Ana Hidalgo Cabrillana, 2008. "On Finance As A Theory Of Tfp, Cross-Industry Productivity Differences, And Economic Rents," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 49(2), pages 437-473, 05.
  38. Hopenhayn, Hugo & Rogerson, Richard, 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 915-38, October.
  39. Andrés Erosa, 2000. "Financial Intermediation and Occupational Choice in Development," UWO Department of Economics Working Papers 20003, University of Western Ontario, Department of Economics.
  40. Boyd, John H & Smith, Bruce D, 1994. "How Good Are Standard Debt Contracts? Stochastic versus Nonstochastic Monitoring in a Costly State Verification Environment," The Journal of Business, University of Chicago Press, vol. 67(4), pages 539-61, October.
  41. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
Full references (including those not matched with items on IDEAS)

This item is featured on the following reading lists or Wikipedia pages:

  1. Economic Logic blog

When requesting a correction, please mention this item's handle: RePEc:aea:aecrev:v:100:y:2010:i:4:p:1875-91. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jane Voros)

or (Michael P. Albert)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.