Financial Intermediation and Delegated Monitoring
The Review of Economic Studies Ltd.
Financial Intermediation and Delegated Monitoring Author(s): Douglas W. Diamond Source: The Review of Economic Studies, Vol. 51, No. 3 (Jul., 1984), pp. 393-414 Published by: Oxford University Press Stable URL: http://www.jstor.org/stable/2297430 . Accessed: 03/09/2011 10:01
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Review of Economic Studies (1984) LI, 393-414 ? 1984 The Society for Economic Analysis Limited
0034-6527/84/00280393$02.00
Financial
and Intermediation
Delegated
Monitoring
DOUGLAS W. DIAMOND University of Chicago
This paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders. It presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary. Diversification within an intermediary serves to reduce these costs, even in a risk neutral economy. The paper presents some more general analysis of the effect of diversification on resolving incentive problems. In the environment assumed in the model, debt contracts with costly bankruptcy are shown to be optimal. The analysis has implications for the portfolio structure and capital structure of intermediaries.
INTRODUCTION This
Financial Intermediation and Delegated Monitoring Author(s): Douglas W. Diamond Source: The Review of Economic Studies, Vol. 51, No. 3 (Jul., 1984), pp. 393-414 Published by: Oxford University Press Stable URL: http://www.jstor.org/stable/2297430 . Accessed: 03/09/2011 10:01
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.
Oxford University Press and The Review of Economic Studies Ltd. are collaborating with JSTOR to digitize, preserve and extend access to The Review of Economic Studies.
http://www.jstor.org
Review of Economic Studies (1984) LI, 393-414 ? 1984 The Society for Economic Analysis Limited
0034-6527/84/00280393$02.00
Financial
and Intermediation
Delegated
Monitoring
DOUGLAS W. DIAMOND University of Chicago
This paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders. It presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary. Diversification within an intermediary serves to reduce these costs, even in a risk neutral economy. The paper presents some more general analysis of the effect of diversification on resolving incentive problems. In the environment assumed in the model, debt contracts with costly bankruptcy are shown to be optimal. The analysis has implications for the portfolio structure and capital structure of intermediaries.
INTRODUCTION This