Credit market equilibrium with bank monitoring and moral hazard

We characterize a credit market equilibrium in which banks coexistwith capital markets and firms obtain funding from both sources.An incentive problem exists between the firm's insiders andoutside providers of capital. Banks can provide not only creditbut also monitoring services. We show that when banks cannotprecommit to a particular level of monitoring there is a uniquecredit market equilibrium with firms being financed with a combinationof bank credit and external capital. In this equilibrium, amarginal substitution of bank credit for capital market financingwould raise the firm's stock price.