EQUILIBRIUM LOAN CONTRACTS AND ENDOGENOUS GROWTH IN THE PRESENCE OF ASYMMETRIC INFORMATION

This paper considers an endogenous growth model in which an informatio nal asymmetry exists between capital producing borrowers and lenders a s to the borrower's ability to successfully operate an investment proj ect. In contrast to previous models of this genre, the lender can indu ce self-selection either by rationing a fraction of borrowers, or by u sing a costly screening technology, or by a mix of the two. The equili brium contract's form and the growth rate of output are mutually depen dent and are jointly determined. The effect of the lower cost of scree ning on the growth rate of output has been considered. We show that a decline in the screening cost, paradoxically, may lower the growth rat e of output. Only when a threshold level of sophistication is crossed will the benefit of an advanced financial sector become evident in a h igher growth rate.