Costs and benefits of creditor concentration: An empirical approach
AbstractHigh concentration of creditors can have two beneficial effects on borrowers: i) by enhancing lendersÂ’ ability to monitor, it can reduce the likelihood of financial distress; ii) by reducing coordination failure among creditors, it can help a distressed firm to avoid bankruptcy. However, a strong probability of debt renegotiation can exert a feedback effect on the likelihood of financial distress, by generating perverse ex-ante incentives for borrowers (soft budget constraint). Moreover, high concentration of creditors can expose borrowers to greater liquidity risks. Using Italian data on manufacturing firms, we try to separate empirically these conflicting effects. Our results show that, if we control for the soft-budget-constraint and liquidity effects, high concentration of bank credit reduces the likelihood of financial distress and liquidation, as predicted by the literature on relationship banking. But these benefits do not come without costs: i) enhanced monitoring is offset by the soft-budget-constraint effect and ii) higher concentration of credit lines increases liquidity risks and thus makes both financial distress and liquidation more likely. Ultimately, the overall effect of more concentrated banking relations is a lower probability of liquidation but a higher probability of financial distress. This helps to explain the widespread existence of multiple but asymmetric banking relations in Italy.
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Bibliographic InfoPaper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 645.
Date of creation: Nov 2007
Date of revision:
financial distress; liquidazione; monitoring; relationship lending; soft budget constraint;
Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
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