Do Financial Institutions Matter?

Authors

  • Franklin Allen

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    • Wharton School, University of Pennsylvania. I am grateful to Douglas Diamond, David Easley, Yukihiko Endou, Douglas Gale, Bruce Grundy, Maureen O'Hara, and John Percival for helpful discussions. Lily Fang provided excellent research assistance.

Abstract

In standard asset pricing theory, investors are assumed to invest directly in financial markets. The role of financial institutions is ignored. The focus in corporate finance is on agency problems. How do you ensure that managers act in shareholders' interests? There is an inconsistency in assuming that when you give your money to a financial institution there is no agency problem, but when you give it to a firm there is. It is argued that both areas need to take proper account of the role of financial institutions and markets. Appropriate concepts for analyzing particular situations should be used.

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