FINANCIAL INTERMEDIATION AS DELEGATED MONITORING: A SIMPLE
EXAMPLE
Banks and other financial intermediaries are the main source of external funds to firms. Intermediaries provided more than 50 percent of external funds from 1970 to 1985 in the United States, Japan, the United Kingdom, Germany, and France (Mayer 1990). Why do investors first lend to banks who then lend to borrowers, instead of lending directly? What is the financial technology that gives the banks the ability to rve as middleman? To answer the questions, this article prents a simplified version of the model in Financial Intermediation and Delegated Monitoring (Diamond 1984).[1] The results explain the key role of debt contracts in bank finance and the importance of diversification within financial intermediaries. The framework can be ud to understand the organizational form of intermediaries, the role of banks in capital formation, and the effects of policies that limit bank diversification.[2]
Financial intermediaries are agents, or groups of agents, who are delegated the authority to invest in financial asts. In particular, they issue curities in order to buy other curities. A first step in understanding intermediaries is to describe the features of the financial markets where they play an important role and highlight what allows them to provide beneficial rvices. It is important to understan
d the financial contracts written by intermediaries, how the contracts differ from tho that do not involve an intermediary, and why the are optimal financial contracts. Debt contracts are central to the understanding of intermediaries. The cost of monitoring and enforcing debt contracts issued directly to investors (widely held debt) is a reason that raising funds through an intermediary can be superior. Debt contracts include contracts issued to intermediaries by the borrowers that they fund (the are bank loans) and the contracts issued by intermediaries when they borrow from investors (the are bank deposits). Portfolio diversification within financial intermediaries is the financial-engineering technology that facilitates a bank's transformation of loans that need costly monitoring and enforcement into bank deposits that do not.
This article both simplifies and extends the analysis in Diamond (1984). Adding an assumption about the probability distribution of the returns of borrowers' projects makes the analysis simpler. There are a few new results that extend the analysis becau this article drops the assumption that nonpecuniary penalties can be impod on borrowers. The change of assumption implies that them is a minimum level of bank profitability required to provide incentives for bankers to properly monitor loans. This article is not a general survey of the financial intermediation literature. Two recent surveys are Hellwig (1991) and Bhattacharya and Thakor (1993). For a survey of the role of debt in corporate finance, e Lacker (1991).
Intermediaries provide rvices: this is clear becau intermediaries issue "condary" financial asts to buy "primary" financial asts. If an intermediary provided no rvices, investors who buy the condary curities issued by the intermediary might as well purcha the primary curities directly and save the intermediary's costs. To explain the sorts of rvices that intermediaries offer, it is uful to categorize them in terms of a simplified balance sheet. Ast rvices are tho provided to the issuers of the asts
held by an intermediary, e.g., to bank borrowers. An intermediary that provides ast rvices is distinguished by its atypical ast portfolio. Relative to an intermediary that provides no ast rvices, it will concentrate its portfolio in asts that it has a comparative advantage in holding. The model prented below provides a foundation for understanding this aspect of intermediation, showing that reduced monitoring costs are a source of this comparative advantage.[3] There are other important aspects of intermediation that we do not discuss here: liability rvices and transformation rvices. Liability rvices are tho provided to the holder of intermediary liabilities in addition to the rvices provided by most other curities. Examples include the ability to u bank demand deposits as a means of payment and the personalization of contingent contracts available from life insurance companies. Some liability rvices, such as check clearing, are well und
erstood, while others relate to difficult issues in microeconomic theory regarding the role of money. Transformation rvices involve the conversion of illiquid asts into liquid liabilities, offering improved risk sharing and better liquidity compared with investment in the asts held by intermediaries (e Diamond and Dybvig [1983] and Diamond [1995]). Although there may be interactions between the types of rvice, this article focus only on ast rvices.
If intermediaries provide ast rvices, they provide rvices to borrowers who issue asts to them. That is, it matters to the issuer of an ast that the ast is to be held by an intermediary rather than directly by investors. Some costs are lower if the ast is held by an intermediary rather than a large number of individuals. The imperfections that give ri to costs of issuing curities by primary borrowers also give ri to similar costs to an intermediary that issues deposits. I examine how a financial intermediary acting as a middleman can lead to net cost savings, and I develop the implications of this role for the structure of intermediaries. The model yields strong predictions about the contracts ud by intermediaries and this provides a tting to analyze important issues in banking policy.
1. AN OVERVIEW OF FINANCIAL INTERMEDIATION: THE COSTS AND BENEFITS OF MONITORING
Theories bad on the collection of private information by an intermediary require that there be some benefit to using this additional information in lending. A key result in the agency theory literature is that monitoring by a principal can allow improved contracts. The net demand for this monitoring also depends on the cost of monitoring. This cost depends on the number of lenders who contract with a given borrower.
In contracting situations involving a single lender and a single borrower, one compares the physical cost of monitoring with the resulting savings of contracting costs. Let K be the cost of monitoring and S the savings from monitoring. When there are multiple lenders involved, either each must be able to monitor the additional information directly at a total cost of m x K, where m is the number of lenders per borrower, or the monitoring must be delegated to someone.[4] Delegating the monitoring gives ri to a new private information problem: the person doing the monitoring as agent now has private information. It is not even
verifiable whether the monitoring has been undertaken. Delegated monitoring can lead to delegation costs. Let D denote the delegation cost per borrower. A complete financial intermediary theory bad on contracting costs of borrowers must model the delegation costs and explain why intermediation leads to an overall improvement in the t of available contracts. That is, delegated monitoring pays
when
a dK + D </= min [S, m x K],
becau K + D is the cost using an intermediary, S is the cost without monitoring, and m x K is the cost of direct monitoring.
The model in this article illustrates the more general results in Diamond (1984), which analyzes delegation costs by characterizing the organizational structure and contractual form that minimize the costs of delegating monitoring to an intermediary. The first step in studying the benefits of intermediation is to find the best available contracts between borrowers and lenders if there is no intermediary and no monitoring. The optimal unmonitored financial contract between a borrower and lenders is shown to be a debt contract that involves positive expected deadweight liquidation costs which are necessary to provide incentives for repayment.[5] The gross demand for monitoring aris becau one can u lower cost contracts (with reduced liquidation costs), if the project's return can be monitored, with an ex ante cost saving of S.
Monitoring is costly, especially if duplicated. If not duplicated, the act of monitoring must be delegated, and then the information obtained is not publicly obrved. As a result of the remaining inf
ormation disadvantage of tho who do not monitor, there may be delegation costs associated with providing incentives for delegated monitoring. The best way to delegate monitoring is for the delegated monitor to issue unmonitored debt, which will be subject to liquidation costs. The delegated monitor is a financial intermediary becau it borrows from small investors (depositors), using unmonitored debt (deposits) to lend to borrowers (who loans it monitors).永远爱你的英语怎么说
2. AN EXAMPLE OF OPTIMAL DEBT WITHOUT DELEGATED MONITORING
Consider a borrower who needs to rai a large quantity of capital. All lenders and borrowers are risk neutral, but borrowers have no capital, and each lender's capital to invest is small relative to the amount needed to fund the borrower's investment. The borrower needs to rai 1 (where the units are millions of dollars, and the units will be mentioned only parenthetically), while each investor has 1/m units to invest, implying that a borrower needs to rai capital from m investors if m > 1. The example assumes that m is very large: m = 10,000, and each lender has capital or 0.0001 ($100). Monitoring the borrower costs K = 0.0002 ($200), and duplicated monitoring by each of m investors costs mK = 2 and is prohibitively expensive. Becau monitoring is expensive, one should examine the best contract available without any monitoring.
Investors do not obrve the borrower's operations directly, not even its sales or cash flows. How can the lenders write a contract in which they do not need to monitor this information?
The Best Contract without Monitoring
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The firm needs to rai 1 ($1 million), and each investor requires an expected return of r = 5%. All lenders and the borrower agree that the borrower has a profitable, positive net prent value project to fund, but only the borrower will obrve how profitable it turns out to be. The borrower can consume any part of the project's return that he does not pay out to the investor. The interpretation is that the borrower can appropriate the return to himlf, since no one el obrves the project's success. If the project is a retail store, the borrower can take some sales in cash to himlf. More generally, the borrower can inflate costs. In practice, the net cash flows to the firm are very unobrvable for many firms. In addition, most other conflicts of interest faced by borrowers can be reinterpreted as equivalent to the borrower's ability to retain underreported cash. The ability to retain underreported cash is simply the most extreme example of a conflict of interest.
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The project costs 1 to fund, and its realized value is a random variable with realization denoted by V. The distribution of V, the value of the project, known to all borrowers and lenders is
视频剪辑培训H = 1.4 million, with probability P = 0.8,
L = 1 million, with probability 1 - P = 0.2.
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A Simple Candidate for a Contract is Equity
An equity contract in this context is a profit-sharing agreement, where the profit shared depends on the profits reported by the borrower. Let the fraction of reported profits that goes to the outside investor be a, while the borrower retains a fraction 1 -- a, plus any underreported profits. Suppo that the borrower's contract is just to pay a fraction of reported profits, with no other details or penalties specified. The borrower's payoff, given the true value of V and the reported value, denoted by Z, is V -- aZ. What profit will the borrower report if he is suppod to pay out a fraction of it? The borrower will choo the smallest value of Z. Supposing that the borrower can't make the lender take a share of a reported loss (by reporting Z < 0), the borrower will report Z = 0. A simple profit-sharing contract works very poorly when profits cannot be verified. It does not even provide incentives to repay L = 1, the minimum possible value of profit. Even adding the requirement that profit reports can never be less than L = 1 does nothing to induce higher payments.
No matter what the true value of V, the best respon of the borrower to a profit sharing contract is to
pay the lowest possible value. If there is no cost to the borrower of understating the amount, the borrower always does. Even if the lender knows the value of V, if the borrower obtains it first and thus controls it, the lender will not be paid unless the borrower suffers some conquence of not paying.
What Can the Lender Do If the Borrower Claims a Low Amount?
The lender would like to impo a penalty for low payments to give incentives for higher payments. There are two interpretations. The lender can liquidate the project if the borrower pays too little, preventing the borrower from absconding with it, or the lender can impo a nonmonetary penalty on the borrower. Bankruptcy in the world today is some combination of the two actions. In ancient history, the nonmonetary penalties were very common, i.e., debtors' prisons and physical penalties. Such sanctions are now illegal, but the loss of reputation of a borrower of a bankrupt firm is similar to a sanction.
Bankruptcy, Liquidation, and the Optimal Liquidation Policy
Suppo that it is not possible to impo a penalty on the borrower or take other asts (outside the business) that are valued by the borrower. See Diamond (1984) for analysis when the nonpecunia
ry penalties are possible. The only sanction available to give the borrower an incentive to pay is liquidation of the borrower's asts (as in Diamond [1989,1991]). To focus on the inefficiency of disrupting firm operations, I assume that liquidating the firm's ast gives no proceeds to the lender or to the borrower. The results are similar when liquidation yields a positive amount that is much less than the value of the unliquidated ast. Liquidation and bankruptcy are uful penalties that a borrower can avoid by paying the debt, but regular liquidation is not a good way to run a firm. How does one specify an optimal financial contract between investor and borrower when one can decide to liquidate (to penalize the borrower) or not, contingent on any payment.?
Liquidation is best ud as a payment-contingent penalty in the following way. If the lender is ever to liquidate for a given payment, he also should liquidate for all lower payments. Suppo instead that the lender does not liquidate if 1 is paid but will liquidate for some higher payment. Then, whenever the borrower has at least 1, he will avoid liquidation by paying 1 and keep the remainder for himlf. This makes meaningless the threat to liquidate given higher payments, becau the payment will never exceed 1.
The borrower will pay the lowest amount that avoids liquidation, and keep the rest for himlf. The only exception is if the borrower has insufficient funds to pay that amount. This implies a description
of the optimal financial contract without monitoring: lect a payment, f, that, if paid, avoids liquidation. The lender then liquidates for all lower payments. This implies that the optimal contract when monitoring is impossible is a debt contract with face f. The face value includes the promid payment of principal and interest.
世博展馆Determination of the Face Value of Unmonitored Debt
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This ction determines the minimum face value, f, of unmonitored debt which will lead to payments with an expected return of 5 percent on a loan of 1 ($1 million), or an expected value of 1.05.
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Suppo f = 1. When V = 1, the borrower pays 1 (paying less would result in liquidation). The borrower gets 0, which is as much as if he paid any lower amount. When V = 1.4, the borrower pays 1 (to avoid
