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Banks' equity stakes in borrowing firms: A corporate finance approach

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  • Jukka Vauhkonen

    (Bank of Finland)

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    Abstract

    In most countries, banks’ equity holdings in firms that borrow from then are rather small. In light of the theoretical literature, this is somewhat surprising. For example, according to agency cost models, allowing banks to hold equity would seem to alleviate firms’ asset substitution moral hazard problem associated with debt financing. This idea is formalised in John, John, and Saunders in a model where banks are modeled as passive investors and bank loans are the only source of outside finance for firms. In this paper, we argue that this alleged benefit of banks’ equity holding is small or non-existent when banks are modeled explicitly as active monitors and firms have access also to market finance.

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    File URL: http://128.118.178.162/eps/game/papers/0404/0404003.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Game Theory and Information with number 0404003.

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    Date of creation: 29 Apr 2004
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    Handle: RePEc:wpa:wuwpga:0404003

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    Web page: http://128.118.178.162

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    Keywords: banks’ equity holdings; firms’ capital structure; social welfare;

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    1. Takalo, Tuomas & Toivanen, Otto, 2003. "Equilibrium in financial markets with adverse selection," Research Discussion Papers 6/2003, Bank of Finland.
    2. George W. Evans & Seppo Honkapohja, 2004. "Friedman’s money supply rule vs optimal interest rate policy," Macroeconomics 0405002, EconWPA.
    3. Iftekhar Hasan & Heiko Schmiedel, 2004. "Do networks in the stock exchange industry pay off? European evidence," International Finance 0405002, EconWPA.
    4. Samu Peura & Esa Jokivuolle, 2004. "Simulation-based stress testing of banks’ regulatory capital adequacy," Finance 0405003, EconWPA.
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