Close-Relationships Between Banks and Firms: Is It Good or Bad?
This paper investigates the issues involved in cross-ownership between banks and firms. The idea is that congruity among the parties in control of the bank and the firm allows to save on monitoring costs, but it gives rise to a conflict of interest between on one hand the parties in control of the bank and on the other hand the outside investors, as for example depositors, of the bank. Moreover, when monitoring of borrowing is important and unobservable by outsiders, there is interdependency among incentives, so that the conflict of interest may reduce even further incentives to monitor all other projects in the bank portfolio. Nevertheless, the paper shows that there are benefits from cross-ownership, whenever the bank involved in the relationship is debt financed and well diversified.
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