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

Douglas Diamond

Journal of Political Economy, 1991, vol. 99, issue 4, 689-721

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. Copyright 1991 by University of Chicago Press.

Date: 1991
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