Empirical evidence suggests that banks playa unique role in the savings-investment process, affecting firms' cost of capital and the level of investment. We argue that bank uniqueness is related to how the design of bank loan contracts allows banks to affect borrowers' choice of project risk. Unlike corporate bonds, bank loans are typically secured senior debt which contain embedded options allowing the bank to "call" the loan. The option allows the bank tv control borrowers' risk-taking activity via renegotiation of the loan. We analyze the renegotiation outcomes and show that: (1) debt forgiveness occurs; (2) monitoring by the bank is not always successful in preventing the borrower from increasing risk; (3) renegotiated interest rates are not monotonic in borrower type; (4) inefficient liquidation can occur. In renegotiation seniority and collateral are crucial because they allow the bank to threaten the borrower and liquidate inefficient projects. We show that when a prepayment option is included in the bank loan contract, bank debt is more valuable (ex ante) to borrowing firms than corporate debt; it lowers the cost of capital.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Publisher Info
Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
4273.
Length: Date of creation: Feb 1993 Date of revision: Handle: RePEc:nbr:nberwo:4273
Note: CF Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A. Phone: 617-868-3900 Email: Web page: http://www.nber.org More information through EDIRC
For technical questions regarding this item, or to correct its listing, contact: ().
Related research
Keywords:
Other versions of this item:
Find related papers by JEL classification: G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Anil K. Kashyap & Jeremy C. Stein, 1994.
"Monetary Policy and Bank Lending,"
NBER Chapters,
in: Monetary Policy, pages 221-261
National Bureau of Economic Research, Inc.
[Downloadable!]
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Hind Sami, 2005.
"Financial Distress and Reputational Concerns,"
Working Papers
0509, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure.
[Downloadable!]