Lender Moral Hazard and Reputation in Originate-to-Distribute Markets∗

In a dynamic model of originate-to-distribute lending, we examine whether reputation concerns can incentivize a bank to monitor loans it has sold. Investors believe that banks with fewer recent loan defaults are more likely to monitor (“have higher reputation”). In equilibrium, banks monitor more and retain a smaller loan fraction when their reputations are high. Monitoring is harder to sustain in periods with uncommonly large spikes in loan demand (“booms”), especially for low-reputation banks, which are more likely to accommodate boom demand and forgo monitoring. Increased likelihood of facing a rival with reputation concerns also weakens monitoring incentives. ∗We thank Viral Acharya (discussant), Andres Almazan, Thomas Chemmanur, Thierry Foucault, Paolo Fulghieri, Thomas Gehrig (discussant), Bruno Gerard, Dirk Hackbarth (discussant), Charles Kahn, Rich Mathews (discussant), Elvira Sojli, Ajay Subramanyam, Zaime Zender (discussant), and seminar participants at the 2012 SFS Finance Cavalcade (University of Virginia), 2012 Paris Spring Corporate Finance Conference, 2012 Western Finance Association meetings (Las Vegas), 2012 European Finance Association meetings (Copenhagen), 2012 Summer Conference at the Indian School of Business, 2012 University of Oxford Reputation Symposium, 1st Oxford Financial Intermediation Theory Conference, Carlos III University, Erasmus University, Federal Reserve Banks of New York and Philadelphia, Georgia State University, London School of Economics, Norwegian Business School in Oslo, Oxford University, Pompeu Fabra University, Rotterdam Business School, Tilburg University, and the University of Minnesota, for their helpful comments or discussions on issues examined in the paper. All remaining errors are our responsibility. †Carlson School of Management, University of Minnesota; email: [email protected] ‡C. T. Bauer College of Business, University of Houston; email: [email protected]