The paper establishes a theoretical link between financial innovation and economic development. In an economic environment where product development takes place, it is shown that the gains from long-term financial contracting go beyond the minimization of costs associated with frictions in the capital markets. They can also result in the adoption of more efficient technologies by the production sector. Furthermore, the model suggests that financial innovation is also a byproduct of economic development, providing a possible explanation for the lack of long-term financial markets in less-developed economies.