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Banks versus Bonds: A Simple Theory of Comparative Financial Institutions

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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.

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File URL: http://cowles.econ.yale.edu/P/cd/d11a/d1100.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1100.

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Length: 74 pages
Date of creation: May 1995
Date of revision:
Handle: RePEc:cwl:cwldpp:1100

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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Cited by:
  1. Sandeep Baliga & Ben Polak, 1998. "Banks Versus Bonds: the Emergence and Persistence of Two Financial Systems," Discussion Papers 1221, Northwestern University, Center for Mathematical Studies in Economics and Management Science.

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