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Financial Intermediation, Costly Information Production, and Small Industry Growth

ABSTRACT This paper studies the mechanism of financial intermediaries' information production and its impact on industry-level growth, especially its difference between industries that differ in the technological composition of small firms. We build a growth model in which (i) both loan contracts and production of information on borrowing firms' productivities are endogenously determined, and (ii) the smaller firm's productivity is more costly to assess. Analytic results show that the smaller firm's innately greater degree of informational opaqueness hinders its growth, especially in the early stage of a country's financial development. We provide some evidence supporting the key mechanism.