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Discussion Paper Details

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Title: Innovation, 'Bank' Monitoring and Endogenous Financial Development

Author(s): Angel de la Fuente and José Maria Marín Vigueras

Publication Date: November 1995

Keyword(s): Financial Development and Growth

Programme Area(s): International Macroeconomics

Abstract: This paper analyses the interaction between capital accumulation, technological progress and financial development. Growth is sustained by the development of new varieties of intermediate goods. Innovation is risky and the probability of success depends on entrepreneurs' actions, which can only be imperfectly observed by outsiders through the use of a costly monitoring technology. Financial intermediaries emerge to avoid the duplication of monitoring activities and negotiate incentive contracts with innovators. Monitoring intensity is determined endogenously as a function of factor prices and determines the risk premium required by risk-averse researchers. Natural forward and backward links arise between finance and innovation. By allowing for better risk sharing, closer monitoring yields a higher level of innovative activity in equilibrium and faster growth. Under plausible assumptions, the resulting changes in factor prices lower the relative cost of monitoring, leading to a further increase in the efficiency of the financial sector.

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Bibliographic Reference

de la Fuente, A and Marín Vigueras, J. 1995. 'Innovation, 'Bank' Monitoring and Endogenous Financial Development'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=1276