Economic Development and Relationship-Based Financing

Economic Development and Relationship-Based Financing

Mariassunta Giannetti, Xiaoyun Yu

Series number :

Serial Number: 
153/2007

Date posted :

January 01 2007

Last revised :

October 30 2018
SSRN Share

Keywords

  • Finance and growth • 
  • Information production • 
  • Competition for capital • 
  • Exchange competition

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.

 

 

Published in

Published in: 
Publication Title: 
The Review of Corporate Finance Studies
Description: 
Volume 4, Issue 1, Pages 69–107

Authors

Real name:
Xiaoyun Yu