Multiple Lenders, Strategic Default and the role of Debt Covenants (original) (raw)

Debt contracts, collapse and regulation as competition phenomena

1997

We study a credit market with adverse selection and moral hazard where sufficient sorting is impossible. The crucial novel feature is the competition between lenders in their choice of contracts offered. Qualities of investment projects are not observable by banks and investment decisions of entrepreneurs are not contractible, but output conditional on investment is. We explain the empirically observed prevalence of debt contracts as an equilibrium phenomenon with competing lenders. Equilibrium contracts must be immune against raisin-picking by competitors. Non-debt contracts allow competitors to offer sweet deals to particularly good debtors, who will self-select to choose such a deal, while bad debtors distribute themselves across all offered contracts.

Debt contracts and collapse as competition phenomena

Journal of Financial Intermediation, 2006

Attar Campioni Piaser - Multiple Lending and Constrained Efficiency in the Credit Market

This paper studies the relationship between competition and incentives in an economy with financial contracts. We concentrate on non-exclusive credit relationships, those where an entrepreneur can simultaneously accept more than one contractual offer. Several homogeneous lenders compete on the contracts they offer to finance the entrepreneur's investment project. We model a common agency game with moral hazard, and characterize its equilibria. As expected, notwithstanding the competition among the principals (lenders), non-competitive outcomes can be supported. In particular, positive profit equilibria are pervasive. We then provide a complete welfare analysis and show that all equilibrium allocations turn out to be constrained Pareto efficient.

A General Equilibrium Analysis of the Credit Market

2009

Abstract I analyse a model of incentive contracts where principals who each possesses the same monitoring technologies, contract with agents from a pool of individuals differing in their wealth endowments. Principals and agents are matched to form partnerships, and the matches are subject to a double-sided moral hazard problems. Agents need to borrow from the principals to finance their projects. In equilibrium, the payoffs to the principals and agents are determined endogenously.

A Model of Strategic Default with Competing Lenders∗

2003

I study a model with strategic default that could be used to analyze international financial transactions in a multicountry model, where there is a set of financial intermediaries operating internationally and a set of local lenders operating at country level. Due to the presence of a transaction cost on cross border flows, the model generates Nash equilibria of a Cournot game such that financial intermediaries and local lenders simultaneously lend to the same local entrepreneurs. When borrowers have low wealth, a "no-default constraint" is binding and there exists equilibria in which total investment is greater than the level achieved when lending is only provided by a single intermediary. However, contrary to standard models with strategic default, direct transfers may fail to increase total investment and a tax on international financial transactions may be welfare improving.

Optimal Debt Contracts and Moral Hazard Along the Business Cycle

2002

We analyze the Pareto optimal contracts between lenders and borrowers in a model with asymmetric information. The model generalizes the Rothschild-Stiglitz pure adverse selection problem by including moral hazard. Entrepreneurs with unequal "abilities" borrow to finance alternative investment projects which differ in degree of risk and productivity. We determine the endogenous distribution of projects as functions of the amount of loanable funds, when lenders have no information about borrowers' ability and technological choices. Then, we embed these results in a dynamic competitive economy and show that the average quality of the selected projects in equilibrium may be high in recessions and low in booms. This phenomenon may generate (a) multiple steady states, (b) a smaller impact of exogenous shocks on output relative to the full information case, (c) endogenous fluctuations.

Equilibrium corporate finance and intermediation

This paper analyzes a class of competitive economies with production, incomplete financial markets, and agency frictions. Firms take their production, financing, and contractual decisions so as to maximize their value under rational conjectures. We show that competitive equilibria exist and that shareholders always unanimously support firms' choices. In addition, equilibrium allocations have well-defined welfare properties: they are constrained efficient when information is symmetric, or when agency frictions satisfy certain specific conditions. Furthermore, equilibria may display specialization on the part of identical firms and, when equilibria are constrained inefficient, may exhibit excessive aggregate risk. Financial decisions of the corporate sector are determined at equilibrium and depend not only on the nature of financial frictions but also on the consumers' demand for risk. Financial intermediation and short sales are naturally accounted for at equilibrium.

Mutual loan-guarantee societies in monopolistic credit markets with adverse selection

Journal of Financial Stability, 2012

In many countries, Mutual Loan-Guarantee Societies (MLGSs) are assuming ever-increasing importance for small business lending. In this paper we provide a theory to rationalise the raison d'être of MLGSs. The basic intuition is that the foundation for MLGSs lies in the inefficiencies created by adverse selection, when borrowers do not have enough collateralisable wealth to satisfy collateral requirements and induce self-selecting contracts. In this setting, we view MLGSs as a wealth-pooling mechanism that allows otherwise inefficiently rationed borrowers to obtain credit. We focus on the case of large, complex urban economies where potential entrepreneurs are numerous and possess no more information about each other than do banks. Despite our extreme assumption on information availability, we show that MLGSs can be characterized by assortative matching in which only safe borrowers have an incentive to join the mutual society.

Moral Hazard and Capital Structure Dynamics

SSRN Electronic Journal, 2002

We base a contracting theory for a start-up firm on an agency model with observable but nonverifiable effort, and renegotiable contracts. Two essential restrictions on simple contracts are imposed: the entrepreneur must be given limited liability, and the investor's earnings must not decrease in the realized profit of the firm. All message game contracts with pure strategy equilibria (and no third parties) are considered. Within this class of contracts/equilibria, and regardless of who has the renegotiating bargaining power, debt and convertible debt maximize the entrepreneur's incentives to exert effort. These contracts are optimal if the entrepreneur has the bargaining power in renegotiation. If the investor has the bargaining power, the same is true unless debt induces excessive effort. In the latter case, a non-debt simple contract achieves efficiency -the non-contractibility of effort does not lower welfare. Thus, when the non-contractibility of effort matters, our results mirror typical capital structure dynamics: an early use of debt claims, followed by a switch to equity-like claims.

Multiple Lenders, Strategic Default and the role of Debt Covenants (original) (raw)

Related papers