S-WoPEc
 
Scandinavian Working Papers in Economics
HomeAboutSeriesSubject/JEL codesAdvanced Search
Institute for Financial Research SIFR Research Report Series, Institute for Financial Research

No 50:
Favoritism or Markets in Capital Allocation?

Mariassunta Giannetti () and Xiaoyun Yu ()

Abstract: Casual observation suggests that capital allocation is often driven by favoritism and connections rather than by market mechanisms and information on future expected returns. We investigate when favoritism or markets emerge as an equilibrium outcome in the allocation of capital. We show that when information is unreliable and costly, financiers do not have incentives to investigate distant investment opportunities and allocate capital to entrepreneurs they are familiar with (favoritism). If the pool of saving is relatively small, favoritism can lead to an efficient allocation of investment. As the economy develops and its pool of saving increases, information production and the identification of distant investment opportunities (markets) become crucial for efficient investment decisions. Nevertheless, favoritism may emerge in equilibrium and investors may find it optimal to fund low quality entrepreneurs if they are familiar with them. Since competition for capital is low in an equilibrium with favoritism, entrepreneurs enjoy high rents. Thus, even high quality entrepreneurs may have no incentive to join markets with standards that foster information acquisition, but rather run inefficiently small firms.

Keywords: Finance and growth; information production; competition for capital; exchange competition; (follow links to similar papers)

JEL-Codes: G10; G30; (follow links to similar papers)

45 pages, March 15, 2007

Before downloading any of the electronic versions below you should read our statement on copyright.
Download GhostScript for viewing Postscript files and the Acrobat Reader for viewing and printing pdf files.

Full text versions of the paper:

sifr-wp50.pdf    PDF-file
Download Statistics

Questions (including download problems) about the papers in this series should be directed to Anki Helmer ()
Report other problems with accessing this service to Sune Karlsson () or Helena Lundin ().

Programing by
Design by Joachim Ekebom

Handle: RePEc:hhs:sifrwp:0050 This page was generated on 2014-12-14 19:26:51