Abstract
A bank may use the private information that it acquires through monitoring to hold up borrowers. This “information monopoly” of the bank may inefficiently distort the borrower’s investment decisions in environments where moral hazard is prevalent. The paper analyses how this problem is resolved within bank-firm relationships. In the benchmark case when the bank can contractually commit to future actions, the optimal contract turns out to be ambiguous in nature. When commitment contracts cannot be written, firms have an incentive to develop multiple banking relationships in order to decrease the “inside” banks’ bargaining power. However, with costly monitoring, this may defeat the initial purpose for contracting with a financial intermediary, namely information production. The paper argues that when contractual commitment is not feasible, bank size may serve as an alternative commitment device that prevents the bank from holding up borrowers in the future.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
Berger, Allen N., and Gregory F. Udell. “Relationship Lending and Lines of Credit in Small Firm Finance.” Journal of Business 68 (1995), 351–382.
Berger, Allen N., and Gregory F. Udell. “Universal Banking and the Future of Small Business Lending.” In: A. Saunders and I. Walter, eds., Financial System Design: The Case for Universal Banking. Irwin, 1996.
Berger, Allen N., and Gregory F. Udell. “The Economics of Small Business Finance: The Roles of Private Equity and Debt Markets in the Financial Growth Cycle.” Journal of Banking and Finance 22, no. 6–8 (1998), 613–673.
Berger, Allen N., et al. “The Effect of Bank Mergers and Acquisitions on Small Business Lending.” Journal of Financial Economics 50, no. 2 (1998), 187–229.
Bernheim, Douglas B., and Michael D. Whinston. “Incomplete Contracts and Strategic Ambiguity.” American Economic Review 88, no. 4 (1998), 902–932.
Besanko, David, and Anjan V. Thakor. “Competitive Equilibrium in the Credit Market Under Asymmetric Information.” Journal of Economic Theory 42, no. 1 (1987), 167–182.
Bester, Helmut. “Screening vs. Rationing in Credit Markets with Imperfect Information.” American Economic Review 75, no. 4 (1985), 850–855.
Boot, Arnoud W. A., and Anjan V. Thakor. “Can Relationship Banking Survive Competition?” Journal of Finance 55, no. 2 (2000), 679–713.
Boot, Arnoud W.A., Stuart Greenbaum, and Anjan V. Thakor. “Reputation and Discretion in Financial Contracting.” American Economic Review 83, no. 5 (1993), 1165–1183.
Boyd, John H., and Edward C. Prescott. “Financial Intermediary-Coalitions.” Journal of Economic Theory 38, no. 2 (1986), 211–232.
Broecker, Thorsten. “Credit-Worthiness Tests and Interbank Competition.” Econometrica 58, no. 2 (1990), 429–452.
Campbell, T., and W. Kracaw. “Information Production, Market Signalling, and the Theory of Intermediation.” The Journal of Finance 35 (1980), 863–882.
Carletti, Elena. “The Structure of Bank Relationships, Endogenous Monitoring, and Loan Rates.” Journal of Financial Intermediation 13, no. 1 (2004), 58–86.
Cole, Rebel A., Lawrence G. Goldberg, and Lawrence J. White. “Cookie-Cutter versus Character: The Micro Structure of Small Business Lending by Large and Small Banks.” New York University, Salomon Center Working Paper: S/99/12, 1999.
Detragiache, Enrica, Paolo Garella, and Luigi Guiso. “Multiple Versus Single Lending Relationships: Theory and Evidence.” Journal of Finance 55, no. 3 (2000), 1133–1161.
Diamond, Douglas W. “Financial Intermediation and Delegated Monitoring.” Review of Economic Studies 51 (1984), 393–414.
Diamond, Douglas W. “Monitoring and Reputation: The Choice Between Bank Loans and Directly Placed Debt.” Journal of Political Economy 99, no. 4 (1991), 689–721.
Dinς, Serdar I. “Bank Reputation, Bank Commitment, and the Effects of Competition in Credit Markets.” Review of Financial Studies 13, no. 3 (2000), 781–812.
Engelbrecht-Wiggans, Richard, Paul R. Milgrom, and Robert J. Weber. “Competitive Bidding and Proprietary Information.” Journal of Mathematical Economics 11 (1983), 161–169.
Gilson, Stuart C., Kose John, and Larry H.P. Lang. “Troubled Debt Restructurings: An Empirical Study of Private Reorganization of Firms in Default.” Journal of Financial Economics 27, no. 2 (1990), 315–353.
Gorton, Gary, and James Kahn. “The Design of Bank Loan Contracts.” Review of Financial Studies 13, no. 2 (2000), 331–364.
Greenbaum, Stuart, George Kanatas, and Itzhak Venezia. “Equilibrium Loan Pricing Under the Bank Client Relationship.” Journal of Banking and Finance 13 (1989), 221–235.
Hart, Oliver, and John Moore. “Foundations of Incomplete Contracts.” Review of Economic Studies 66, no. 1 (1999), 115–138.
Hausch, Donald B., and Lode Li. “A Common Value Auction Model with Endogenous Entry and Information Acquisition.” Economic Theory 3 (1993), 315–334.
Houston, Joel, and Christopher James. “Bank Information Monopolies and the Mix of Private and Public Debt Claims.” Journal of Finance 51, no. 5 (1996), 1863–1889.
James, Christopher. “Some Evidence on the Uniqueness of Bank Loans.” Journal of Financial Economics 19, no. 2 (1987), 217–235.
Leland, H., and D. Pyle. “Information Asymmetries, Financial Structure and Financial Intermediation.” The Journal of Finance 32 (1977), 371–387.
Lummer, S., and J. McConnell. “Further Evidence on the Bank Lending Process and the Reaction of the Capital Markets to Bank Loan Agreements.” Journal of Financial Economics 25 (1989), 99–122.
Maskin, Eric, and Jean Tirole. “Unforeseen Contingencies and Incomplete Contracts.” Review of Economic Studies 66, no. 1 (1999), 83–114.
Ongena, Steven, and David C. Smith. “What Determines the Number of Bank Relationships? Cross-country Evidence.” Journal of Financial Intermediation 9, no. 1 (2000), 26–56.
Padilla, A. J., and M. Pagano. “Endogenous Communication Among Lenders and Entrepreneurial Incentives.” The Review of Financial Studies 10, no. 1 (1997), 205–236.
Padilla, A. J., and M. Pagano. “Sharing Default Information as a Borrower Discipline Device.” European Economic Review 44 (2000), 1951–1980.
Pagano, Marco, and Tullio Jappelli. “Information Sharing in Credit Markets.” Journal of Finance 48, no. 5 (1993), 1693–1718.
Petersen, Mitchell A., and Raghuram G. Rajan. “The Benefits of Lending Relationships: Evidence from Small Business Data.” Journal of Finance 49, no. 1 (1994), 3–37.
Rajan, Raghuram G. “Insiders and Outsiders: The Choice Between Informed and Arm’s-Length Debt.” The Journal of Finance 47, no. 4 (1992), 1367–1400.
Riordan, Michael H. “Competition and Bank Performance: A Theoretical Perspective.” In: Colin Mayer and Xavier Vives, eds., Capital Markets and Financial Intermediation. Cambridge University Press, 1993.
Sharpe, S. A. “Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships.” Journal of Finance 55 (1990), 1069–1087.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Jean-Baptiste, E.L. Information Monopoly and Commitment in Intermediary-Firm Relationships. J Finan Serv Res 27, 5–26 (2005). https://doi.org/10.1007/s10693-005-6410-7
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10693-005-6410-7