Distance to frontier and optimal financial structure

Justin Yifu Lin, Wei Wang and Venite Zhaoyang Xu

Structural Change and Economic Dynamics, 2022, vol. 60, issue C, 243-249

Abstract: This paper studies endogenous change of financial institutions in a Schumpeterian endogenous growth model with uncertain innovation outcome. Technological progress can result from either imitation or innovation. Information about each innovative project can be acquired by paying a fixed cost. Financial intermediaries save the information cost through delegation yet incur an agency cost that results from diversity of opinion. Investors thus face a tradeoff between the information and agency cost. Because the information and agency cost is proportional to the technological frontier and the local technology level respectively, saving the information cost dominates in the early stages of development when the distance to frontier is large. In contrast, avoiding the agency cost dominates as the local technology level approaches the frontier. As a result, economic development is accompanied by a gradual switching of financial structure from intermediaries to markets.

Keywords: Distance to frontier; Diversity of opinion; Financial intermediaries; Financial markets; Schumpeterian growth model (search for similar items in EconPapers)
JEL-codes: E22 G14 G21 L16 O31 O33 O4 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:streco:v:60:y:2022:i:c:p:243-249

DOI: 10.1016/j.strueco.2021.12.001

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