At a lunchtime meeting on 16 June, held to mark the publication of Capital Markets and Financial Intermediation (see box), Colin Mayer presented results of recent research on the respective roles of bond and bank finance in funding large corporations, drawing on papers in the volume. Mayer is Professor of Economics and Finance at the University of Warwick, Co-Director of CEPR's Applied Microeconomics programme, and Chairman of the European Science Foundation Network in Financial Markets. Financial support for the meeting from Cambridge University Press and the hospitality of Hambros Bank Ltd are gratefully acknowledged. The views expressed by Professor Mayer were his own, however, not those of the above institutions nor of CEPR, which takes no institutional policy positions.

Mayer focused on the role of financial intermediation and the rationale for the existence of banks. Bond markets were widely expected in the late 1980s to displace banks as sources of finance to large corporations. The substantial growth in Eurobond issues by UK companies during the 1970s and 1980s was matched by that of US companies driven from domestic markets by increased regulatory rules, which called into question the future role of banks in funding companies whose credit ratings were often superior to their own. Growth of syndicated credit (lending to corporate borrowers by banks from more than one country) was even more striking for these companies than that of Eurobonds, however, and this more than offset the disintermediation arising from the decline in domestic bank lending.

Mayer then reported the results of an analysis of all Eurobond issues and syndicated credits by US and UK companies during 1972-89. The average size of syndicated credits was larger in most years, while their largest issues (e.g. Eurotunnel and Grand Metropolitan's take-over of Pillsbury) were very much larger; Eurobonds were typically characterized by longer maturities and a more pronounced cyclical pattern. He considered how four groups of theories of financial intermediation may best explain these results: those based on economies of scale, which emphasize savings of transactions costs; `monitoring' theories, which assume that banks screen borrowers and monitor their subsequent performance better than large numbers of bond-holders; `control' theories which emphasize their comparative advantage in enforcing the non-price provisions of loans (e.g. deciding whether or not to extend a credit line when refinancing becomes essential to a firm's survival); and `commitment' theories, which consider banks' development of long-term relationships with borrowers as found in Germany and Japan.

Mayer maintained that scale economies have little relevance for very large firms raising very large sums of money, for which the fee structures of bank and bond finance are very similar. Nor do commitment theories contribute much: firms in the sample use more lead banks in raising loans than they use different currencies, and they switch between lead banks just as much for syndicated credits as for Eurobonds, while bank lending has a shorter average maturity and is procyclical, which cuts against commitment theories. There is some support for monitoring theories, since companies with higher credit ratings tend to make greater use of the bond markets, but it is far from clear that firms of this size and credit rating require independent monitoring by banks.

Mayer found much greater support for control theories. Contracts for syndicated credit covenants are far more complicated than those for Eurobonds, which can serve no purpose unless they enable banks to act when they are violated, while their shorter maturities permit lenders to re-evaluate loans on a regular basis. An econometric analysis revealed that size of issue and of firm jointly account for some 90% of the choice between bank and bond finance: ceteris paribus larger issues (which involve higher risk) are raised through syndicated credits while larger companies (which face lower risk) opt for Eurobonds. Even for the largest firms, therefore, bond markets do not provide a perfect substitute for banks; their continuing role is not undermined by the relative deterioration of their credit ratings and reflects their ability to coordinate investor responses rather than long-term commitments to individual borrowers, although these results in no way undermine theories based on commitment or indeed scale economies in domestic markets, for which they may be a major distinguishing feature.