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Department of |
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See Figure 1 1. Stocks are not the most important source of external financing for businesses. 2. Issuing marketable debt and equity securities is not the primary way in which businesses finance their operations. 3. Indirect finance, which involves the activities of financial intermediaries, is many 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. 5. The financial system is among the most heavily regulated sectors of the economy. 6. Only large, well-established corporations have easy access to securities markets to finance their activities. 7. Collateral is a prevalent feature of debt contracts for both households and businesses. 8. Debt contracts typically are extremely complicated legal documents that place substantial restrictions on the behavior of the borrower. |
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How Transaction Costs Influence Financial
Structure How Financial Intermediaries Reduce Transaction
Costs Economies
of Scale Expertise |
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agency theory: analysis of how asymmetric information problems affect economic behavior |
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Lemons in the Stock and Bond Markets Tools to Help Solve Adverse Selection Problems Private
Production and free-rider problem: occurs when people who do not pay for information take advantage of the information that other people have paid for Government
Regulation to Increase Information Financial
Intermediation Collateral
and Net Wealth net worth: difference between a firm’s assets (what it owns or is owed) and its liabilities (what it owes) Summary |
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Moral Hazard in Equity Contracts: The
Principal-Agent Problem principal-agent problem: occurs when managers own only a small fraction of the firm they work for, while stockholders who own most of the firm’s equity (called the principals) are not the same people as the managers of the firms, who are the agents of the owners Tools to Help Solve the Principal-Agent Problem Production
of Information: Monitoring costly state verification: monitoring process can be expensive in terms of time and money Government
Regulation to Increase Information Financial
Intermediation venture capital firm: pool resources of their partners and use the funds to help budding entrepreneurs start new business; in return for use of venture capital, the firm receives an equity share in the new business Debt
Contracts |
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Tools to Help Solve Moral Hazard in Debt
Contracts Net
Worth and Collateral incentive-compatible: aligns the incentives of the borrower with those of the lender Monitoring
and Enforcement of Restrictive Covenants 1. Covenants to discourage undesirable behavior 2. Covenants to encourage desirable behavior 3. Covenants to keep collateral valuable 4. Covenants to provide information Financial
Intermediation Summary See Table 1 |
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Why do
We Care About Conflicts of Interest? Why Do
Conflicts of Interest Arise? Underwriting
and Research in Investment Banking spinning: occurs when an investment bank allocates hot, but underpriced, IPOs to executives of other companies in return for their companies’ future business with the investment bank Auditing
and Consulting in Accounting Firms What Has
Been Done to Remedy Conflicts of Interest? Sarbanes-Oxley
Act of 2002 Global
Legal Settlement of 2002 APPLICATION
Financial Development and Economic Growth APPLICATION
Is |
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agency theory: economic analysis of the effects of adverse selection and moral hazard financial crises: major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms Factors Causing Financial Crises Increases
in Interest Rates Increases
in Uncertainty Asset
Market Effects on Balance Sheets cash flow: difference between cash receipts and cash expenditures Problems
in the Banking Sector bank panic: multiple bank failures Government
Fiscal Imbalances APPLICATION
Financial Crises in the See Figure 2 insolvent: firms with a negative net worth debt deflation: substantial decline in the price level sets in, leading to a further deterioration in firms’ net worth because of the increased burden of indebtedness APPLICATION
Financial Crises in Emerging-Market Countries: See Figure 3 |
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Disclaimer: pages.slu.edu is a service of Saint Louis University, Saint Louis University does not control, monitor or guarantee the information contained in these sites. For more information » |