DIAMOND MODEL

Let’s consider an economy in which n identical firms would finance investment projects that require one unit of capital whose output is stochastic and available free of charge to the company only. In this context of asymmetric information ex post, investors can obtain the output only if they pay the costs associated with monitoring (the cost of a single monitoring transaction being K). All investors are assumed as small when compared to the project in which they invest, each having 1/m units of capital, hence m investors are needed to finance a project. In case of direct financing, each investor monitors the enterprise total cost nmK
In the case of financing through a financial intermediary that centralises resources and investments on behalf of individual financing entities, the cost of monitoring will be nk.
But who controls the intermediary? Obviously controls exercised by individual investors are inefficient; therefore, it is much more preferable that, regardless of the realisation of the revenue by the intermediary, the broker offers a standard debt contract in which each depositor receives an amount of R / m for a deposit equal to 1 / m. The delegation of monitoring tasks to an intermediary is more efficient when the total costs are lower than those incurred in the case of direct lending: hence when nK + C < nmK (C being the cost of delegation of the intermediary’s monitoring tasks). If investors are "small" when compared to the projects (m> 1), the investment is profitable in terms of expected revenue (Ey> K + R) and there is a need for monitoring in the presence of asymmetric information. The intermediary mechanism is more efficient than direct funding when the number (n) of projects to be funded is sufficiently large.
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Editor: Alberto Maria SORRENTINO
© 2009 ASSONEBB