Chapter 8 Mishkin Notes

An Economic Analysis of
Financial Structure
Why do Financial Institutions Exist?
(Why is Indirect Finance so Important?)

Chapter 8

Chapter Preview
W e take a closer look at why financial institutions exist and how they promote economic efficiency.
Topics include:
• A Few Basic Facts About Financial Structure
• Transaction Costs
• Asymmetric Information: Adverse Selection and
Moral Hazard

Chapter Preview (cont.)
• The Lemons Problem: How Adverse Selection
Influences Financial Structure
• How Moral Hazard Affects the Choice Between
Debt and Equity Contracts
• How Moral Hazard Influences Financial
Structure in Debt Markets

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Basic Facts About Financial Structure
Throughout the World
• The chart on the next slide shows how non-financial business get external funding in the U.S., Germany, Japan, and
Canada.
• Notice that, although many aspects of these countries are quite different, the sources of financing are somewhat consistent, with the U.S. being different in its focus on debt.

Sources of External Finance

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8-5

Eight Basic Facts of Financial Structure
1. Stocks are not the most important source of external financing for businesses [Direct Finance]
2. Issuing marketable debt and equity securities is not the primary way in which businesses finance their operations [Direct Finance]

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Eight Basic Facts of Financial Structure
3. Indirect finance, which involves the activities of financial intermediaries, is m any times more important than direct finance, in which businesses raise funds directly from lenders in financial markets.
4. Financial intermediaries, particularly banks, are the most important source of external funds used to finance businesses.

Eight Basic Facts of Financial Structure
5. The financial system is among the most heavily regulated sectors of economy.
6. Only large, well -established corporations have easy