Banks as Better Monitors and Firms' Financing Choices in Dynamic General Equilibrium
AbstractThis paper builds a dynamic general equilibrium model that emphasizes banks' comparative advantage in monitoring financial distress in order to explain firms' choice between bank loans and market debt. Banks can deal with financial distress more cheaply than bond holders, but this requires a higher initial expenditure proportional to the loan size. In contrast, bond issues may involve a small fixed cost. Entrepreneurs' choice of bank or bond financing depends on their net worth. The steady state of the model can explain why smaller firms tend to use more bank financing and why bank financing is more prevalent in Europe than in the US. A higher fixed cost of issuing market debt is a key factor in replicating the higher use of bank financing relative to market debt in Europe. Finally, we find that for plausible calibrations one can predict aggregate quantities just as well using a model with only one type of loan with costs of financial distress that are an average of the costs for bank loans and market debt.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 23958.
Date of creation: 10 May 2008
Date of revision: 01 Jun 2010
financial frictions; costly state verification; financial distress;
Find related papers by JEL classification:
- G3 - Financial Economics - - Corporate Finance and Governance
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
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