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Financial Intermediation and Delegated Monitoring

Douglas W. Diamond

The Review of Economic Studies · 1984 · 8,651 citations

doi.org/10.2307/2297430

Abstract

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.

Cite this paper

Diamond, D. W. (1984). Financial intermediation and delegated monitoring. The Review of Economic Studies, 51(3), 393. https://doi.org/10.2307/2297430

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