This paper proposes a model of financial markets and corporate finance, with asymmetric
information and no taxes, where equity issues, bank debt, and bond financing coexist
in equilibrium. The relationship banking aspect of financial intermediation is emphasized:
firms turn to banks as a source of investment mainly because banks are good at helping
them through times of financial distress. This financial flexibility is costly since
banks face costs of capital themselves (which they attempt to minimize through securitization).
To avoid this intermediation cost, firms may turn to bond or equity financing, but
bonds imply an inefficient liquidation cost and equity an informational dilution
cost. We show that in equilibrium the riskier firms prefer bank loans, the safer
ones tap the bond markets, and the ones in between prefer to issue both equity and
bonds. This segmentation is broadly consistent with stylized facts.