Investment in Relationship-Specific Assets: Does Finance Matter ?

Existing literature sees opportunistic behaviour of contractual partners as the main reason why rational agents underinvest in relationship-specific assets. We look beyond this well-know holdup problem and argue that financial vulnerability and short-term planning horizon can also lead to such underinvestment. Subsequently, banks can stimulate growth-enhancing investment in relationship-specific assets by signalling creditworthiness and long-term planning horizon of their borrowers. We empirically confum this hypothesis by showing that industries dependent on relationship-specific investment from their suppliers grow disproportionately faster in countries with a strong banking sector. Our work establishes a novel channel through which finance affects the real economy. It also complements the literature that has stressed legally binding contracts as a standard way to promote investment in relationship-specific assets.