Relationships, Competition, and the Structure of Investment Banking Markets
Previous studies have acknowledged the tradeoff between relationships and competition in financial intermediation. In this paper, we explore the structural determinants of this tradeoff in the investment banking market, by deriving it from the underlying relationship technology. In the model, each of several banks incurs a sunk cost to establish a relationship with the same firm; all compete for doing its deals. Alternatively, the firm can do deals with other banks on an arm’s-length basis. We study the role of a self-enforcing norm that restrains price undercutting on the incentives to make relationship-specific investments. We find that banks establish relationships even without local or aggregate monopoly power. Moreover, relationship banks make profits despite a competitive fringe of arm’s-length banks. Finally, a dual market structure emerges in equilibrium - a small number of relationship banks serve firms that make large and frequent deals; a competitive arm’s-length segment serves firms that make small and infrequent deals; and, competitive conditions in the fringe segment do not affect the relationship segment. In this way, we reconcile the coexistence of competitive and seemingly collusive features of this industry, which have been noted by many observers. We apply our framework to provide a logic for antitrust analysis of the industry, to examine the consequences of global competition and discuss the effect of the Internet on bank-firm relationships.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Enrica Detragiache & Paolo Garella & Luigi Guiso, 2000. "Multiple versus Single Banking Relationships: Theory and Evidence," Journal of Finance, American Finance Association, vol. 55(3), pages 1133-1161, 06.
- Matthews, John O., 1994. "Struggle and Survival on Wall Street: The Economics of Competition Among Securities Firms," OUP Catalogue, Oxford University Press, number 9780195050639, July.
- Milton Harris & Bengt Holmstrom, 1981.
"A Theory of Wage Dynamics,"
488, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Tufano, Peter, 1989. "Financial innovation and first-mover advantages," Journal of Financial Economics, Elsevier, vol. 25(2), pages 213-240, December.
- Elsas, Ralf & Krahnen, Jan Pieter, 1998.
"Is relationship lending special? Evidence from credit-file data in Germany,"
Journal of Banking & Finance,
Elsevier, vol. 22(10-11), pages 1283-1316, October.
- Elsas, Ralf & Krahnen, Jan Pieter, 1998. "Is relationship lending special? Evidence from credit-file data in Germany," CFS Working Paper Series 1998/05, Center for Financial Studies (CFS).
- Mayer, Colin, 1987.
"New Issues in Corporate Finance,"
CEPR Discussion Papers
181, C.E.P.R. Discussion Papers.
- Fudenberg, Drew & Maskin, Eric, 1986. "The Folk Theorem in Repeated Games with Discounting or with Incomplete Information," Econometrica, Econometric Society, vol. 54(3), pages 533-54, May.
- Dutta, Prajit K & Madhavan, Ananth, 1997. " Competition and Collusion in Dealer Markets," Journal of Finance, American Finance Association, vol. 52(1), pages 245-76, March.
- Mitchell A. Petersen & Raghuram G. Rajan, 1994.
"The Effect of Credit Market Competition on Lending Relationships,"
NBER Working Papers
4921, National Bureau of Economic Research, Inc.
- Smith, Clifford Jr., 1986. "Investment banking and the capital acquisition process," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 3-29.
- Lummer, Scott L. & McConnell, John J., 1989. "Further evidence on the bank lending process and the capital-market response to bank loan agreements," Journal of Financial Economics, Elsevier, vol. 25(1), pages 99-122, November.
- Petersen, Mitchell A & Rajan, Raghuram G, 1994. " The Benefits of Lending Relationships: Evidence from Small Business Data," Journal of Finance, American Finance Association, vol. 49(1), pages 3-37, March.
- Jun-Koo Kang & Anil Shivdasani & Takeshi Yamada, 2000. "The Effect of Bank Relations on Investment Decisions: An Investigation of Japanese Takeover Bids," Journal of Finance, American Finance Association, vol. 55(5), pages 2197-2218, October.
- Anand, Bharat N & Galetovic, Alexander, 2000.
"Information, Nonexcludability, and Financial Market Structure,"
The Journal of Business,
University of Chicago Press, vol. 73(3), pages 357-402, July.
- Bharat N. Anand & Alexander Galetovic, 1996. "Information, Nonexcludability, and Financial Market Structure," Documentos de Trabajo 7, Centro de Economía Aplicada, Universidad de Chile.
- William J. Wilhelm, 1999. "Internet Investment Banking: The Impact Of Information Technology On Relationship Banking," Journal of Applied Corporate Finance, Morgan Stanley, vol. 12(1), pages 21-27.
- James, Christopher, 1987. "Some evidence on the uniqueness of bank loans," Journal of Financial Economics, Elsevier, vol. 19(2), pages 217-235, December.
- Shockley, Richard L & Thakor, Anjan V, 1997. "Bank Loan Commitment Contracts: Data, Theory, and Tests," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 517-34, November.
- S. Baranzoni & P. Bianchi & L. Lambertini, 2000. "Market Structure," Working Papers 368, Dipartimento Scienze Economiche, Universita' di Bologna.
- Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
- Masahiko Aoki & Serdar Dinc, 1997. "Relational Financing as an Institution and its Viability under Competition," Working Papers 97011, Stanford University, Department of Economics.
- Hsuan-Chi Chen & Jay R. Ritter, 2000. "The Seven Percent Solution," Journal of Finance, American Finance Association, vol. 55(3), pages 1105-1131, 06.
- Williamson, Oliver E, 1979. "Transaction-Cost Economics: The Governance of Contractural Relations," Journal of Law and Economics, University of Chicago Press, vol. 22(2), pages 233-61, October.
When requesting a correction, please mention this item's handle: RePEc:edj:ceauch:96. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.