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.
Keywords
Moral hazardDebtReputationLoanProfitability indexBusinessInterest rateBondMonetary economicsFinancial systemCost of funds indexFinanceEconomicsMicroeconomicsIncentive
Affiliated Institutions
Related Publications
The Benefits of Lending Relationships: Evidence from Small Business Data
ABSTRACT This paper empirically examines how ties between a firm and its creditors affect the availability and cost of funds to the firm. We analyze data collected in a survey o...
Insiders and Outsiders: The Choice between Informed and Arm's‐Length Debt
ABSTRACT While the benefits of bank financing are relatively well understood, the costs are not. This paper argues that while informed banks make flexible financial decisions wh...
Relationship Lending and Lines of Credit in Small Firm Finance
This article examines the role of relationship lending in small firm finance. It examines price and nonprice terms of bank lines of credit (L/Cs) extended to small firms. The fo...
ON THE PRICING OF CORPORATE DEBT: THE RISK STRUCTURE OF INTEREST RATES*
The value of a particular issue of corporate debt depends essentially on three items: (1) the required rate of return on riskless (in terms of default) debt (e.g., government bo...
INFORMATIONAL ASYMMETRIES, FINANCIAL STRUCTURE, AND FINANCIAL INTERMEDIATION
Numerous markets are characterized by informational differences between buyers and sellers. In financial markets, informational asymmetries are particularly pronounced. Borrower...
Publication Info
- Year
- 1991
- Type
- article
- Volume
- 99
- Issue
- 4
- Pages
- 689-721
- Citations
- 3327
- Access
- Closed
External Links
Social Impact
Altmetric
PlumX Metrics
Social media, news, blog, policy document mentions
Citation Metrics
3327
OpenAlex
Cite This
Douglas W. Diamond
(1991).
Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt.
Journal of Political Economy
, 99
(4)
, 689-721.
https://doi.org/10.1086/261775
Identifiers
- DOI
- 10.1086/261775