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Development and Relationship-Based Financing

Mariassunta Giannetti

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Swedish House of Finance

Xiaoyun Yu

Indiana University - Department of Finance; China Academy of Financial Research (CAFR)

April 2, 2014

ECGI - Finance Working Paper No. 153/2007
AFA 2009 San Francisco Meetings Paper

This paper explores under what conditions financiers allocate capital on the basis of prior relationships with close entrepreneurs, instead of acquiring costly information on distant entrepreneurs. We show that when the economy's capital endowment is relatively small, relationship-based financing is optimal because only high-productivity entrepreneurs receive funding. As the capital endowment increases, costly information acquisition becomes crucial for preventing low-productivity entrepreneurs from being funded. However, financiers may still find it optimal to fund connected entrepreneurs even if these have low productivity. Since competition for capital is low if financing is based on prior relationships, entrepreneurs enjoy high rents. High quality entrepreneurs may thus have no incentives to promote financiers' information acquisition, but rather run inefficiently small firms.

Number of Pages in PDF File: 52

Keywords: Finance and growth; Information acquisition; Competition for capital; Relationship-based vs.arm's length financial systems

JEL Classification: G3, O16

working papers series

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Date posted: March 17, 2008 ; Last revised: April 3, 2014

Suggested Citation

Giannetti, Mariassunta and Yu, Xiaoyun, Development and Relationship-Based Financing (April 2, 2014). ECGI - Finance Working Paper No. 153/2007; AFA 2009 San Francisco Meetings Paper. Available at SSRN: http://ssrn.com/abstract=959188 or http://dx.doi.org/10.2139/ssrn.959188

Contact Information

Mariassunta Giannetti (Contact Author)
Stockholm School of Economics ( email )
P.O. Box 6501
Sveavagen 65
SE-113 83 Stockholm
+46 8 736 9607 (Phone)
+46 8 312 327 (Fax)
HOME PAGE: http://sites.google.com/site/mariassuntagiannetti/Home
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
European Corporate Governance Institute (ECGI)
B-1050 Brussels
HOME PAGE: http://www.ecgi.org
Swedish House of Finance ( email )
Drottninggatan 98
111 60 Stockholm

Xiaoyun Yu
Indiana University - Department of Finance ( email )
1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3521 (Phone)
812-855-5875 (Fax)
China Academy of Financial Research (CAFR)
1954 Huashan Road
Shanghai P.R.China, 200030

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