Financing Development: The Role of Information Costs (Revised August 2009)
FRB Richmond Working Paper No. 08-08R
59 Pages Posted: 11 Dec 2012
Date Written: August 1, 2009
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 features. 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. Quantitative analysis suggests that finance is important for growth.
Keywords: costly-state verification, economic development, financial intermediation, firm size
JEL Classification: E13, O11, O16
Suggested Citation: Suggested Citation