Financial Contractibility and Assets’ Hardness: Industrial Composition and Growth*

One salient characteristic of poorly developed capital markets is the excessive weight they give to the availability of hard assets in the allocation of financial funds. Where external finance contractibility is poor, higher proportions of assets that more easily remain with investors if the relationship breaks down are used in order to sustain external finance. Consistent with this view, I show that industries whose assets are relatively less tangible perform worse in terms of growth and contribution to GDP in countries with poorly developed financial systems. The impact is larger the more dependent an industry is on external finance. The effect is important (comparable to more traditional determinants of specialization and growth), and robust. Firm-level evidence also confirms finance as the link: leverage is less sensitive to tangibility in better-working capital markets.