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Multiple Lenders, Strategic Default and Debt Covenants


Author Info

  • Andrea Attar

    (Department of Economics, Law and Institutions, University of Rome "Tor Vergata")

  • Catherine Casamatta

    (Toulouse School of Economics)

  • Arnold Chassagnon

    (Université de Tours and Paris School of Economics)

  • Jean Paul Décamps

    (Toulouse School of Economics)


This paper investigates how the use of covenants in financial contracts affects competition in capital markets subject to moral hazard. Financial contracts offered by investors are non-exclusive, i.e. entrepreneurs can trade with several investors at a time. To restrict entrepreneurs’ ability to trade with competitors, investors can include in their contracts ex post punishments contingent on the firm’s outside investment or indebtedness, which we interpret as covenants. When covenants are precluded, the equilibrium outcome is always efficient, and unique when the moral hazard problem is severe. Then, the aggregate of lenders earn monopoly profits. If covenants can be included in financial contracts, every incentive compatible individually rational allocation can be supported at equilibrium: market equilibria are indeterminate and Pareto-ranked. Contrary to common wisdom, covenants alone do not enhance competition. We then investigate the impact of two institutional mechanisms (information sharing systems and loan subsidies) to mitigate entrepreneurs’ incentive to trade excessively. Both mechanisms restore efficiency, but only loan subsidies can sustain the competitive outcome as the unique equilibrium allocation.

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Bibliographic Info

Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 261.

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Length: 54 pages
Date of creation: 18 Jan 2013
Date of revision: 18 Jan 2013
Handle: RePEc:rtv:ceisrp:261

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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma

Related research

Keywords: Non-Exclusivity; Credit Rationing; Debt Covenants.;

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Cited by:
  1. Degryse, Hans & Ioannidou, Vasso & von Schedvin, Erik, 2012. "On the Non-Exclusivity of Loan Contracts: An Empirical Investigation," CEPR Discussion Papers 8692, C.E.P.R. Discussion Papers.
  2. Claude Fluet & Paolo G. Garella, 2013. "Debt Rescheduling with Multiple Lenders: Relying on the Information of Others," Cahiers de recherche 1332, CIRPEE.


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