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Economic Development and Relationship-Based Financing

54 Pages Posted: 17 Mar 2008 Last revised: 20 Jun 2016

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 - Kelley School of Business - Department of Finance; China Academy of Financial Research (CAFR)

Multiple version iconThere are 2 versions of this paper

Date Written: September 22, 2014

Abstract

Formal finance involves costly information acquisition about distant entrepreneurs, while relationship-based finance allows financiers to fund a narrow circle of close entrepreneurs without engaging in costly information acquisition. We show that in developing economies with low capital endowments, relationship-based finance is optimal because only high-quality entrepreneurs receive funding. However, formal finance may emerge in equilibrium and has the only effect of shifting rents from entrepreneurs to financiers. In more developed economies with higher capital endowments, formal finance becomes necessary to prevent low-quality entrepreneurs from being funded. Nevertheless, relationship-based financing may persist in equilibrium and capital may be allocated to low-quality close entrepreneurs even when there are high-quality distant entrepreneurs.

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

JEL Classification: G3, O16

Suggested Citation

Giannetti, Mariassunta and Yu, Xiaoyun, Economic Development and Relationship-Based Financing (September 22, 2014). ECGI - Finance Working Paper No. 153/2007; Review of Corporate Finance Studies Forthcoming; ECGI - Finance Working Paper No. 153/2007; AFA 2009 San Francisco Meetings Paper. Available at SSRN: https://ssrn.com/abstract=959188 or http://dx.doi.org/10.2139/ssrn.959188

Mariassunta Giannetti (Contact Author)

Stockholm School of Economics ( email )

P.O. Box 6501
Sveavagen 65
SE-113 83 Stockholm
Sweden
+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)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Xiaoyun Yu

Indiana University - Kelley School of Business - 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
China

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