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Applied macroeconomists (e.g., Eckstein and Sinai (1986) ) have stressed the role of financial variables, such as firm balance sheet positions, in the determination of investment spending and output. Our paper presents a formal analysis of this link. We develop a model of the process of. investment finance in which there is asymmetric information between borrowers and lenders about the quality of investment projects and about the borrower's effort. In this model, the cost of external investmentdoi:10.3386/w2318 fatcat:7nfqzskvobeqvh4yyjy6aofkqe