Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt

1991/08/01 by Douglas W. Diamond · 3,421 citations
Business, Management and Accounting · Economics, Econometrics and Finance · #Banking stability, regulation, efficiency #Bond #Business #Corporate Finance and Governance #Cost of funds index #Debt #Economic theories and models #Economics #Finance #Financial system #Incentive #Interest rate #Loan #Microeconomics #Monetary economics #Moral hazard #Profitability index #Reputation

paper · open access · doi:10.1086/261775

published in Journal of Political Economy 99(4), 689-721 (University of Chicago Press)

openalex publication_date 1991/08/01 · openalex created_date 2025/10/10 · openalex updated_date 2026/08/05

Abstract

This paper determines when a debt contract will be monitored by lenders. This is the choice between borrowing directly (issuing a bond, without monitoring) and borrowing through a bank that monitors to alleviate moral hazard. This provides a theory of bank loan demand and of the role of monitoring in circumstances in which reputation effects are important. A key result is that borrowers with credit ratings toward the middle of the spectrum rely on bank loans, and in periods of high interest rates or low future profitability, higher-rated borrowers choose to borrow from banks.

Citations

• On the Strategic Stability of Equilibria

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