1991/08/01 by Douglas W. Diamond · 23 citations
Economics, Econometrics and Finance · Business, Management and Accounting · #Banking stability, regulation, efficiency #Economic theories and models #Corporate Finance and Governance
paper · doi:10.1086/261775
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.