It has long been recognized that there is a pervasive positive cross-country correlation between the level of a country’s financial development and its level of economic activity (e.g., Goldsmith, 1969, or King and Levine, 1993), with causality possibly running both ways. Finance theory surveyed in Levine (1997) contends that financial development can foster corporate growth because financial intermediaries play a key role in overcoming market frictions due to moral hazard and asymmetric information. These frictions give rise to financial constraints and represent a fundamental source of external finance costs, which ought to be lowered through financial development. Efficient financial institutions provide external finance even to informationally opaque businesses, that is to firms with little information available on their economic and financial status.

There is much survey evidence suggesting that small and young firms from both developed and developing countries are constrained in their access to external finance. Applying the logic of finance theory, it is therefore likely that company size or age serve as effective proxies for the extent of market frictions, particularly the extent of information asymmetries, that firms face. Under this assumption, small and young firms are likely to benefit disproportionately from the development of financial institutions and markets. Yet, so far there is relatively little research asking whether this is the case. In this study, we measure the extent to which the development of national financial systems boosts the growth rate of small and young firms more than that of large and old firms.