Multiple Lenders, Strategic Default and the Role of Debt Covenants
Speaker
Abstract
| This paper investigates the relationship between competition and contract design in credit markets subject to moral hazard. We consider the stylized representation of the market for loans introduced by Holmstrom and Tirole (1997, 1998), and we explicitly model competition among lenders as an extensive form game. Financial contracts are taken to be non-exclusive, which guarantees that borrowers can trade with several lenders at a time. In such a context, we provide a full characterization of the set of equilibrium allocations and we show that the features of market equilibria crucially depend on the financial contracts made available to financiers. If lenders make use of debt contracts only, the equilibrium outcome is unique, and yields monopoly profits to the aggregate of lenders. If covenants contingent on the project’s cash-flow can be included in financial contracts, then every feasible allocations can be supported at equilibrium: market equilibria will be indeterminate and Pareto-ranked. The introduction of institutional mechanisms which prevent borrowers from strategically defaulting on their loans could restore the competitive outcome as the unique equilibrium allocation. |
| Contact information: |
| Viorel Roscovan |
