Transformation Risk, Inefficiency of the Legal System and Financial Dualism in Developing Countries

Developing countries economies are well-known for both the inadequacy of the institutional framework (this is particularly relevant for the legal system) and the presence of informal nancing. The former characteristic signi cantly reduces the e¢ ciency of con- tractual mechanisms. As a result, the importance of transformation risk increases. Such a context induces entrepreneurs and lenders to implement some new non-contractual mechanisms. The diversity of monitoring techniques as well as the heterogeneity of borrowers initial endowments and investment projects lead to an endogenous nancial dualism. Borrowers choose formal or informal nancing according to the quality of their investment project, their initial wealth and to the efficiency of the legal system.