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Strategic bank monitoring and firms’ debt structure

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    Abstract

    Firms choose debt structure and competing banks choose monitoring intensity. Monitoring improves credit allocation, but creates informational lock-in effects in bank-borrower relationships. In a competitive credit market, banks dissipate anticipated profit from serving locked-in borrowers subsequently revealed to the bank as good to attract new borrowers with unknown credit quality. Consequently, banks’ lending strategies result in cross-subsidies from good to bad borrowers. We investigate how firms’ choice of debt structure interacts with the cross-subsidies inherent in banks’ lending strategies. The analysis sheds light on how dynamic bank competition determines monitoring intensity, seniority, and maturity structure in bank dependent industries.

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    Bibliographic Info

    Paper provided by Norges Bank in its series Working Paper with number 2005/10.

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    Length: 35 pages
    Date of creation: 28 Oct 2005
    Date of revision:
    Handle: RePEc:bno:worpap:2005_10

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    Keywords: Corporate debt structure; bank lending; lock-in effects;

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