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Optimal lending contracts

Author

Listed:
  • Christian At
  • Lionel Thomas

Abstract

This paper deals with financial contracting between a lender and a borrower with a project to finance. The borrower is protected by limited liability. We consider that the revenue from the project is observable and verifiable but its distribution is influenced by both the borrower’s choice of action and the project’s quality, which are private information. We find that debt contracts are endogenously optimal, as under moral hazard alone. Moreover, while moral hazard leads to credit rationing for the lowest-quality projects only, adding adverse selection creates a bang-bang result: either all projects or none are credit rationed.

Suggested Citation

  • Christian At & Lionel Thomas, 2017. "Optimal lending contracts," Oxford Economic Papers, Oxford University Press, vol. 69(1), pages 263-277.
    • Handle: RePEc:oup:oxecpp:v:69:y:2017:i:1:p:263-277.
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    File URL: http://hdl.handle.net/10.1093/oep/gpv087
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    Cited by:

    1. Hiriart, Yolande & Thomas, Lionel, 2017. "The optimal regulation of a risky monopoly," International Journal of Industrial Organization, Elsevier, vol. 51(C), pages 111-136.
    2. Mäkinen, Taneli & Sarno, Lucio & Zinna, Gabriele, 2020. "Risky bank guarantees," Journal of Financial Economics, Elsevier, vol. 136(2), pages 490-522.

    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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