Producer Subsidies And Adverse Selection In The Corporate Credit Market
AbstractA model of loan negotiation between a bank and a firm is applied to a situation when the borrowing producer receives support from the government in the form of a sales or investment subsidy. A pre-condition of obtaining government support is the company's expenditure in the form of a lobby "contribution", financed by the producer revenue. The borrowed funds are invested in a new project. The project outcome is uncertain and can lead to a failure by the borrower to service the full amount of debt if the adverse state of nature is realized. The probability and other parameters of this "bankruptcy" outcome depend on the interest rate level and the producer characteristics, such as production costs and the productivity distribution. We consider the case when there are two types of these parameter values, corresponding to good and bad performers. It is shown that the possibility to buy government support affects the use of that part of the revenue which might be necessary to service the debt in adverse states of nature. One possible consequence is then a replacement of the equilibrium with zero bankruptcy probability with the one involving bankruptcy under unsuccessful project outcomes. Another is the possibility of a pooling equilibrium in which poor performers borrow at the same interest rate as good ones, instead of the separating equilibrium that favors good performers.
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Bibliographic InfoArticle provided by The Czech Econometric Society in its journal Bulletin of the Czech Econometric Society.
Volume (Year): 9 (2002)
Issue (Month): 15 ()
risky investment; default; subsidy; signaling;
Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
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