This paper briefly reviews the contemporary literature on relationship banking. We start out with a discussion of the raison d'être of banks in the context of the financial intermediation literature. From there we discuss how relationship banking fits into the core economic services provided by banks and point at its costs and benefits. This leads to an examination of the interrelationship between the competitive environment and relationship banking as well as a discussion of the empirical evidence. Journal of Economic Literature Classification Numbers: G20, G21, L10.

This paper analyzes the optimality of conglomeration. We show that the potential benefits of conglomeration depend critically on the effectiveness of market discipline for stand-alone activities. Effective market discipline reduces the benefits of conglomeration. With ineffective market discipline of stand-alone activities, conglomeration would further undermine market discipline, but may nevertheless be beneficial. In particular, when rents are not too high, the diversification benefits of conglomeration dominate the negative incentive effects. A more competitive environment therefore induces conglomeration. We also show that introducing internal cost-of-capital allocation schemes creates internal market discipline that complements the weak external market discipline of a conglomerate. Our analysis sheds light on the Barings debacle and other recent developments in the banking sector. Journal of Economic Literature Classification Numbers: G20, G21, G34.

Does Europe offer lessons for the consolidation in US banking? In this paper, it is argued that the political dimension in Europe has led to the protection of national flagships and consolidation mainly on a national scale. Lessons for the US are limited. Rather, the regional expansion observed in US banking may offer valuable lessons for imminent cross-border mergers in European banking.

ABSTRACT We study the divestiture decisions of managers who care about their reputations. Managers' divestiture and investment decisions are publicly observable, but managers privately observe signals with respect to the future payoff distribution of investments they have initiated. We establish that in equilibrium there is too little divestiture. These inefficiencies create the opportunity for wealth‐enhancing divestiture‐motivated takeovers. A key result is that only managers of targets with “middle of the road” asset specificity should consider the takeover threat credible. These findings suggest that uniqueness of assets is an important determinant of both agency costs and takeover activity. Our analysis leads to several empirical predictions.

We examine the design of control rights of external financiers, and how these interact with the firm's security issuance and capital structure when the firm's initial owners and managers may disagree with new investors over project choice. The first main result is an ex ante managerial preference for “soft” financial claims that maximize managerial project-choice autonomy, which is in contrast to agency theory. Second, a dynamic “pecking order” of cash, equity, and debt emerges. Additional results explain equity issuance at high prices, the drifting of leverage ratios with stock returns, cash hoarding, and debt usage without taxes, agency, or signaling.

In this article we ask: what kind of information and how much of it should firms voluntarily disclose? Three types of disclosures are considered. One is information that complements the information available only to informed investors (to-be-processed complementary information). The second is information that is orthogonal to that which any investor can acquire and thus complements the information available to all investors (preprocessed complementary information). And the third is information that substitutes for the information of the informed investors in that it reveals to all what was previously known only by the informed (substitute information). Our main results are as follows. First, in equilibrium, all types of firms voluntarily disclose all three types of information. Second, in contrast to the existing literature, complementary information disclosure by firms strengthens investors’ private incentives to acquire information. Substitute information disclosure weakens private information acquisition incentives. Third, while complementary information disclosure has an ambiguous effect on financial innovation incentives, substitute information disclosure weakens those incentives.

This article builds a theory of financial system architecture. We ask: what is a financial market, what is a bank, and what determines the economic role of each? Starting with basic assumptions about primitives—the types of agents and the nature of informational asymmetries—we provide a theory that explains which agents coalesce to form banks and which trade in the capital market. It is shown that borrowers of higher observable qualities access the financial market. Moreover, a financial system in its infancy will be bank-dominated, and increased financial market sophistication diminishes bank lending.