American Economic Review: Vol. 100 No. 4 (September 2010)


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Financing Development: The Role of Information Costs

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Greenwood, Jeremy, Juan M. Sanchez, and Cheng Wang. 2010. "Financing Development: The Role of Information Costs." American Economic Review, 100(4): 1875-91.

DOI: 10.1257/aer.100.4.1875


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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Greenwood, Jeremy (U PA)
Sanchez, Juan M. (Federal Reserve Bank of Richmond and Federal Reserve Bank of St Louis)
Wang, Cheng (Fudan U and IA State U)

JEL Classifications

G21: Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
G31: Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
O16: Economic Development: Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
O33: Technological Change: Choices and Consequences; Diffusion Processes
O41: One, Two, and Multisector Growth Models

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