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Journal of Financial Services Research

11.03.2025

Bank Monitoring and the Business Cycle

verfasst von: Eric Van Tassel

Erschienen in: Journal of Financial Services Research

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Abstract

We use a model to study the financing decisions of a firm when the economic outlook is uncertain. Funding is available from competitive lenders, one of which, at added cost, can monitor the firm and make an informed choice about early liquidation. Under imperfect contracting, we derive a set of competitive loan contracts that induce the informed lender to shape its monitoring activity according to the observed economic conditions. We also find that as the economic outlook worsens, it is more likely that the firm will seek this kind of conditional monitoring by an informed lender.

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We discuss contracting in more detail in Section 2.4.

This can be interpreted as action enabled by a loan covenant, where a low probability is a violation of the covenant.

Given that monitoring reveals \(p_{i}\) and that contracts or covenants can be based on \(p_{i}\), as we mentioned earlier, monitoring in all states can be enforced by requiring that the informed lender always determine what \(p_{i}\) is.

Following Grossman and Hart (1986); Aghion and Bolton (1992), we argue this is due to the complexity of trying to predict and describe ex ante, all the possible different ways unfavorable and favorable economic conditions might look or not look.

In an empirical study, Berlin et al. (2020) find that cross-acceleration clauses are a common feature of loan packages where term loans are paired with debt that is actively monitored by a specific lender.

While the lender is unable to directly observe what effort the entrepreneur chose, on the equilibrium path, the lender can correctly deduce it. For this reason, we allow the planner to make her monitoring choice conditional on effort.

We examine this issue more formally below.

Using an informed lender is more costly.

We provide an example of parameter values in the discussion below.

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Titel: Bank Monitoring and the Business Cycle
verfasst von: Eric Van Tassel
Publikationsdatum: 11.03.2025
Verlag: Springer US
Erschienen in: Journal of Financial Services Research
Print ISSN: 0920-8550
Elektronische ISSN: 1573-0735
DOI: https://doi.org/10.1007/s10693-025-00444-2