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A Theory of Conflicts of Interest in Banking Relationships

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  • Wook Sohn
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    Abstract

    This paper highlights a dark side of banking relationships by elucidating the conditions under which a pre-existing relationship between a lending bank and a borrower can be detrimental to positive valuation effects of loan announcements. The effect of a pre-existing relationship is more likely to be negative when the pre-existing loans are large and firms' screening costs are low. A theoretical model shows that loan announcement's positive effect on borrowers' value due to the standard information advantage can be more than offset by the bank's conflict of interest when the bank's asset quality reputation is poor, i.e. when the probability of the bank holding a bad loan is large.

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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal International Economic Journal.

    Volume (Year): 21 (2007)
    Issue (Month): 2 ()
    Pages: 177-198

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    Handle: RePEc:taf:intecj:v:21:y:2007:i:2:p:177-198

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    Related research

    Keywords: Conflicts of interest; banking relationships; soft-budget constraint; sequential equilibrium;

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