SME-Large Firm Relationships and SMEs’ Investment: Hold-up and the Potential Role of Financial Sector through the Win-win Growth Index

This paper analyzes the effect of SME-large firm relationships on SMEs’ investment in a Schumpeterian framework, and discusses the potential role of financial sector in tackling the problem given relevant information such as the Win-win growth index of Korea. Due to the hold-up issues caused by relationship-specific investment of SMEs, large firms have a strong incentive to behave opportunistically by slashing the ex post price of SME’s intermediate product. This tendency has become stronger as the time span of SME-large firm relationship has gotten shorter and shorter due to rapid changes in technologies and globalization. In analyses using a Schumpeterian growth model and related simulations, this hold-up problem significantly reduces SMEs’ incentive to undertake both equipment investment and R&D, which, in turn, reduces the revenue basis of the financial sector. Therefore, financial sector potentially has a strong incentive to solve this problem as long as they have access to relevant information such as the fairness in price settings and contracts which are intended to be provided by Korea’s Win-win growth index.