Working Paper: CEPR ID: DP1421
Authors: Daron Acemoglu; Fabrizio Zilibotti
Abstract: We analyse 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 possesses 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 in 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
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Economic Development (O29) | Reduced Agency Costs (G34) |
| Increased Number of Projects (O22) | Improved Information (D83) |
| Improved Information (D83) | Reduced Agency Costs (G34) |
| Economic Development (O29) | Increased Number of Projects (O22) |
| Better Information (D83) | More Effective Incentive Schemes (J33) |
| More Effective Incentive Schemes (J33) | Reduced Agency Costs (G34) |
| Banks Produce Information (G21) | Mitigate Inefficiencies (D61) |
| Economic Development (O29) | Improved Information Flow (D83) |
| Improved Information Flow (D83) | Ability to Condition Compensation on Project Success (J33) |