The Allocation of Liability, Delegated Monitoring, and Modes of Financing
University of Essex
March 9, 2009
The paper argues that the industrial organization of the financial services market is determined by the allocation of liability to repay investors. Based on the allocation of liability, the paper examines all the possible modes of organizing finance and delegated monitoring in an economy with costly state verification. Besides the mode of financial intermediation (FI), a mode of direct finance, Conglomeration, also accommodates delegated monitoring and also obtains the benefit of diversification, which, therefore, do not necessarily make FI viable, as the existing literature claims. The paper furthermore finds that, as opposite to what that literature predicts, the monitoring cost favors FI, which empirically predicts that the prevalence of bank financing could increase with the costs of banks' services or with the return rates of banks' loans.
Number of Pages in PDF File: 57
Keywords: Allocation of Liability, Modes of Financing, Delegated Monitoring, Financial Intermediation, Conglomeration
JEL Classification: D86, G00, G30working papers series
Date posted: March 10, 2010 ; Last revised: June 29, 2010
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