Competition in Credit Markets

Since the 1960's, the foundations of finance have either been pure arbitrage or principal agent relationships. This study leaves the Modigliani -Miller world of pure arbitrage -but not the world of equilibria -and turns the principal-agent world upside down. Here the firrns become principals again and banks become agents in the original sense of the word: they act on an auction market. This new view of credit relationships yields a number of interesting insights. In my opinion the most important result is that too close relationships between banks and their borrowers will reduce credit market competition. Michael Troge thus gives an antitrust reason for the Iimitation of bank involvement in non financial firms. This is not a very relevant issue in the United States where legal responsibility already makes it difficult for banks to inuence the decisions of the firm. However, in continental Europe, close relationships between banks and firms are widespread and its effects on firrns are subject to a large debate. The author investigates in a first step the impact of the banks' information ahout borrower quality on the competitiveness of the credit market. Precise in- formation about the credit quality can yield a competitive advantage for the bank but it does not come without cost. Troge endogenizes the amount of informa- tion acquired in a strategic duopoly and obtains two key results: He first shows that too many banks can lead to excessive spending on information acquisition.