Short-Term Contracts as a Monitoring Device
This paper focuses on two separate problems. The first is that frequently, the most profitable use of funds involves long-term investments, which militiates for long-term debt contracts. The second problem is to monitor the investor's use of funds, as exemplified by the U.S. S&L saga, and we argue that short-term debt provides investors, who can withdraw their funds, with a real threat over firms. We show that short-term investors have both desirable incentives to exert control and invest in monitoring, and that this monitoring concern provides an explanation of the often lamented disparity between the maturity of banks' assets and liabilities. We also explore in detail the trade-off between long-term and short-term debt, including the possibility of multiple contracts and of priority rules.
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- Douglas W. Diamond & Philip H. Dybvig, 2000.
"Bank runs, deposit insurance, and liquidity,"
Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
- Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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- Kane, Edward J, 1989. "The High Cost of Incompletely Funding the FSLIC Shortage of Explicit Capital," Journal of Economic Perspectives, American Economic Association, vol. 3(4), pages 31-47, Fall.
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