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This paper evaluates (1) whether the exogenous component of financial intermediary development influences economic growth and (2) whether cross-country differences in legal and accounting systems (e.g., creditor rights, contract enforcement, and accounting standards) explain differences in the level of financial development. Using both traditional cross-section, instrumental variable procedures and recent dynamic panel techniques, we find that the exogenous components of financial intermediary development is positively associated with economic growth. Also, the data show that cross-country differences in legal and accounting systems help account for differences in financial development. Together, these findings suggest that legal and accounting reforms that strengthen creditor rights, contract enforcement, and accounting practices can boost financial development and accelerate economic growth.

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This paper -- a product of the Finance and Private Sector Development Division, Policy Research Department -- is pa't of a larger effort in the department to understand the links between the financial system and economic growth. The study was funded by the Bank's Research Support Budget under the research project "Stock Market Development and Financial Intermediary Growth" (RPO 679-53). Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye, room N9-030, telephone 202-473-8526, fax 202-525- 1155, Internet address psintimaboagye@worldbank.org. December 1996. (44 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less tban fully pollsbed. The papers carry the names of the authors and should be cited accordingly. Tbe findings, interpretations, and conclusions expressed m tbis paper are entirely those of tbe author. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent

. The paper examines the case in which the capital market is populated by informed and uninformed investors. The uninformed try to extract information from informed investors' trades. This opens up the possibility that if informed investors are forced to sell emerging market securities to meet margin calls, for example, this action may be misread by the uninformed investors as signaling low returns in emerging markets. The paper presents a simple model in which this type of Wall Street confusion may result in a collapse in emerging markets' output. * A rough version of these notes was presented at the AEA 1999 New York Meetings, and at the Winter Camp in International Finance, organized by the Center for International Economics (University of Maryland) and the Faculty of Economics (Universidad de los Andes, Bogota, Colombia) in Cartagena, Colombia, January 7-11, 1999. I would like to acknowledge with thanks useful comments by Enrique Mendoza, Maury Obstfeld, and other seminar partici...

P. Szegö is at the Università de Roma 'La Sapienza. ' The opinions expressed do not necessarily reflect those of the Board of Governors or its staff. The authors thank the Wharton Financial Institutions Center for sponsoring the conference on which the special

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We consider a setting in which a risk-neutral agent/entrepreneur with limited capital seeks external financing for a project which pays stochastic cash flows over many periods. These cash flows are unobservable and unverifiable by outside investors. We identify the optimal long-term financial contract. In this contract, the agent is induced to pay investors via the threat of the loss of control of the project. After solving for the contract as an optimal mechanism, we then demonstrate that it can be implemented by a combination of standard forms of long-term debt contracts. We also extend our analysis to allow for renegotiation of the contract. The model allows for both exogenous and endogenous determination of payoffs in the event of project termination. Our analysis is also general enough to allow for cash flows that arrive continuously. This allow us to address the optimal frequency with which payments to investors are made. Interestingly, we show that it may be optimal for payments to occur at regular, discrete intervals.

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This paper explores a possible link between financial development and trade in manufactures. The theoretical model focuses on the role of financial intermediaries in facilitating large-scale, high-return projects and shows that economies with better-developed financial sectors have a comparative advantage in manufacturing industries. We provide evidence for this hypothesis, first proposed by Kletzer and Bardhan (1987), using a 30-year panel for 65 countries. Controlling for country-specifice#ects and possible reverse causality, we show that financial development exerts a large causal impact on the level of both exports and the trade balance of manufactured goods