Monitoring and reputation: The choice between bank loans and directly placed debt
Open accessAbstract
This paper determines when a debt contract will be monitored by lenders. This is the choice between borrowing directly (issuing a bond, without monitoring) and borrowing through a bank that monitors to alleviate moral hazard. This provides a theory of bank loan demand and of the role of monitoring in circumstances in which reputation effects are important. A key result is that borrowers with credit ratings toward the middle of the spectrum rely on bank loans, and in periods of high interest rates or low future profitability, higher-rated borrowers choose to borrow from banks.
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Firms with access to public debt markets may try to reduce the control of their banks by issuing public debt, even though public debt may entail higher costs.
“Some research suggests that these ®rms may try to reduce the control of their banks by issuing public debt, even though public debt may entail higher costs (Diamond, 1991(Diamond, , 1993;;Rajan, 1992;Houston and James, 1996).”
From The economics of small business finance: The roles of private equity and debt markets in the financial growth cycle (1998) · cites this paper as Diamond, 1991
Cites
Financial intermediation and delegated monitoring
Diamond, D. W. (1984) · The Review of Economic Studies · doi:10.2307/2297430 · Cited by 8,476 · see citing works
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N. Berger, A., & F. Udell, G. (1998) · Journal of Banking & Finance · doi:10.1016/s0378-4266(98)00038-7 · Cited by 3,690 · see citing works
“29Arelated issue is the extent to which the public reputation of the firm affects the terms of credit faced by the small business versus the private information held by the primary bank gained through relationship lending (i.e., reputation versus monitoring as in Diamond 1991).”
Chapter 12 Finance and Growth: Theory and Evidence
Levine, R. (2005) · Handbook of Economic Growth · doi:10.1016/s1574-0684(05)01012-9 · Cited by 2,889 · see citing works
The role of information and financial reporting in corporate governance and debt contracting
Armstrong, C. S., Guay, W. R., & Weber, J. P. (2010) · Journal of Accounting and Economics · doi:10.1016/j.jacceco.2010.10.001 · Cited by 1,494 · see citing works
The value of bank durability: Borrowers as bank stakeholders
SLOVIN, M. B., SUSHKA, M. E., & POLONCHEK, J. A. (1993) · The Journal of Finance · doi:10.1111/j.1540-6261.1993.tb04708.x · Cited by 418 · see citing works
Do Banking Shocks Affect Borrowing Firm Performance? An Analysis of the Japanese Experience
Kang, J.-K., & Stulz, R. M. (1998) · doi:10.2139/ssrn.136708 · Cited by 392 · see citing works
Finance, Growth, and Inequality
Levine, R. (2021) · IMF Working Papers · doi:10.5089/9781513583365.001 · Cited by 62 · see citing works
- Authors
- Diamond, D. W.
- Affiliations
- Federal Reserve (US)
- Corresponding author
- Diamond, Douglas W.
- ORCID
- Diamond, Douglas W.
- Venue
- Journal of Political Economy
- Publisher
- University of Chicago Press
- Published
- 1991-08
- Volume
- 99
- Issue
- 4
- Pages
- 689-721
- ISSN
- 0022-3808 (ISSN-L)
- 1537-534X
- OpenAlex
- W2118889105
- Cited by
- 3,331
- References
- 1
- Citations by year
- 2026: 76 · 2025: 142 · 2024: 122 · 2023: 119 · 2022: 105 · 2021: 171 · 2020: 143 · 2019: 153 · 2018: 146 · 2017: 159 · 2016: 128 · 2015: 115 · 2014: 119 · 2013: 124 · 2012: 140
- FWCI
- 47.17
- Type
- journal article
- Language
- en
- Open access
- Licence
- cc-by-nc-nd
- Locations
- Journal of Political Economy (publishedVersion)
- Knowledge@UChicago (University of Chicago) (submittedVersion, cc-by-nc-nd)
- University of Chicago
- Funders
- National Science Foundation (8896223)
- Yale University
- University of Chicago
- Yale School of Management
- Topics
- Social Sciences › Economics, Econometrics and Finance › Finance › Banking stability, regulation, efficiency
- Social Sciences › Economics, Econometrics and Finance › Finance › Credit Risk and Financial Regulations
- Social Sciences › Business, Management and Accounting › Accounting › Corporate Finance and Governance
- Keywords
- bank lending, bond issuance, monitoring, moral hazard, reputation effects, credit ratings, interest rates, debt contracts
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