Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 607: Agency costs in the process of development

Daron Acemoglu () and Fabrizio Zilibotti ()
Additional contact information
Daron Acemoglu: Massachusetts Institute of Technology, Postal: 77 Massachusetts Avenue, Cambridge, MA 02139-4307 , USA
Fabrizio Zilibotti: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 91 Stockholm, Sweden

Abstract: We analyze an economy where production is subject to moral hazard. The degree of the incentive (agency) costs introduced by the presence of moral hazard naturally depends on the information structure in the economy; it is cheaper to induce correct incentives in a society which posesses better ex post information. The degree of ex post information depends on the number of projects and entrepreneurs in the economy; the more projects, the better the information. This implies that at the early stages of development, the range of projects and the amount of information are limited and agency costs are high. Since the information created by a project is an externality on others, the decentralized economy is constrained inefficient; in particular, it does not `experiment' enough. The analysis of the role of information also opens the way to an investigation of the development of financial institutions. We contrast the information aggregation role of stock markets and information production role of banks. Because the amount of available information increases with development, our model predicts the pattern of financial development observed in practice; banks first and stock markets later.

Keywords: Agency Costs; Development; Information; Financial Institutions; Social Experimentation

JEL-codes: D82; E44; G20

40 pages, October 31, 1997

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