Banks versus Bonds: A Simple Theory of Comparative Financial Institutions

Sandeep Baliga () and Ben Polak ()
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Ben Polak: Dept. of Economics, Yale University, http://cowles.econ.yale.edu/faculty/polak.htm

No 1100, Cowles Foundation Discussion Papers from Cowles Foundation, Yale University

Abstract: We use a simple, graphical moral hazard model to compare monitored bank lending versus non-monitored bond issues as sources of external funds for industry. We contrast the conditions that theoretically favor each system, such as the size and number of firms, with conditions prevailing when these financial systems were developed during the British and German Industrial Revolutions. Then, to address the question why different systems have persisted, we embed the model in an entry game in which firm size and number are endogenous. We show that multiple equilibria can exist if financiers take the industrial structure as given and vice versa. Finally, we compare these equilibria in welfare terms.

JEL-codes: N20 D82 G20 (search for similar items in EconPapers)
Date: 1995-05
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