The author develops a model of bank-firm relationships on the basis of
the following general idea: Banks want to prevent moral hazard on the
side of their customers. In particular they want to prevent their
business customers to use bank credit for purposes different from those
that have been negotiated thus damaging the bank's interest. The idea of
this model is relatively simple. Banks do not extend a loan if the
project for which the money is intended will probably be un- profitable.
They extend the loan if the success of the project is highly probable
and if the revenues from that project are greater than the expenses of
the bank for monitoring the customer. Assuming as Miarka does that the
results from a successful project are certain, this model is an
equivalent to minimizing moni- toring costs. In fact, this is the
outcome of the model. The banks are known to monitor their loans. They
thereby signal to the capital market that they have tested the project.
Therefore, the buyer of bonds of the company on the capital market may
rest assured that the project is financially sound. The buyers of bonds
thus avoid monitoring costs and can grant better credit conditions than
the banks. Pur- chasers of bor. . ds are free riders on the monitoring
of the banks. Miarka tests his model econometrically. The results are
amazingly supportive of the model.