Firms sometimes commit fraud by altering publicly reported information to be more favorable, and investors can monitor firms to obtain more accurate information. We study equilibrium fraud and monitoring decisions. Fraud is most likely to occur in relatively good times, and the link between...

After making a loan, a bank finds out if the loan needs contract enforcement (quot;monitoringquot;); it also decides whether to lay off credit risk in order to release costly capital. A bank can lay off credit risk by either selling the loan or by buying insurance through a credit default swap...

Although monitoring borrowers is thought to be a major function of financial institutions, the presence of other claimants reduces an institutional lender's incentive to engage in costly monitoring. Thus loan contracts must be structured so as to enhance this incentive. Short-term debt gives the...

We study whether the socially optimal level of stability of the banking system can be implemented with regulatory capital requirements in a multi-period general equilibrium model of banking. We show that: (i) bank capital is costly because of the unique liquidity services provided by demand...

Major shareholders can choose between undertaking costly actions that improve firm value (quot;monitoringquot;) and trading on private information. If investors face some chance of liquidity needs, share prices do not fully reveal how much monitoring occurs; thus, higher liquidity demand makes...

When banks act as delegated monitors of borrowing firms in a finite economy, two factors help banks dominate direct lending: portfolio diversification, which increases with bank size, and bank capitalization, which diminishes with size. With free entry into banking, intermediated equilibria are...

Although monitoring borrowers is thought to be a major function of financial institutions, the presence of other claimants reduces an institutional lender's incentives to do so. Thus loan contracts must be structured to enhance the lender's incentives to monitor. Covenants make the effective...

When a financial institution monitors firms that it finances, it acquires private information, creating a lemons problem when the institution needs financing. Since debt is less sensitive than equity to firm-specific information, holding debt improves the institution's liquidity. Debt's lower...

The savings/investment process in capitalist economies is organized around financial intermediation, making them a central institution of economic growth. Financial intermediaries are firms that borrow from consumer/savers and lend to companies that need resources for investment. In contrast, in...