Knut Wicksell Working Paper Series,
Lund University, Knut Wicksell Centre for Financial Studies

Abstract: Existing literature highlights opportunistic behavior as the main reason why rational agents underinvest in relationship-specific assets (the hold-up problem). However, a supplier would also be reluctant to undertake relationship-specific investment if she cannot observe financial stability or planning horizon of a buyer. By combining insights from research on relationship-specific investment and signaling role of financial intermediaries, we argue that a strong banking sector can alleviate these information asymmetries between buyers and suppliers. We empirically confirm this hypothesis by showing that industries dependent on relationship-specific investment from their suppliers grow disproportionately faster in countries with a strong banking sector.

Keywords: Financial development; relationship-specific investment; growth

JEL-codes: G21; O16; O40

36 pages, June 19, 2013

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