MONITORING, LIQUIDATION, AND SECURITY DESIGN

By identifying the possibility of imposing a credible threat of liquid ation as the key role of informed (bank) finance in a moral hazard con text, we characterize the circumstances under which a mixture of infor med and uniformed (market) finance is optimal, and explain why bank de bt is typically secured, senior, and tightly held We also show that th e effectiveness of mixed finance may be impaired by the possibility of collusion between the firms and their informed lenders, and that in t he optimal renegotiation-proof contract informed debt capacity will be exhausted before appealing to supplementary uniformed finance.