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Multiple Lenders, Strategic Default and Covenants

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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)

Abstract

We study competition in capital markets subject to moral hazard when investors cannot prevent side trading. Perfect competition is impeded by entrepreneurs’ threat to borrow excessively from multiple lenders and to shirk. As a consequence, investors earn positive rents at equilibrium. We then analyze how investors’ ability to design financial contracts with covenants deals with this counterparty externality. We show that enlarging investors’ contracting opportunities generates a severe market failure: with covenants, market equilibria are indeterminate and Pareto ranked. Market outcomes are then determined by designing specific financial institutions. Information sharing systems restore efficiency but leave a positive rent to investors. A mechanism of investors-financed subsidies to entrepreneurs mitigates the threat of default and sustains the competitive 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: 57 pages
Date of creation: 18 Jan 2013
Date of revision: 08 Aug 2014
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
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Related research

Keywords: Counterparty Externality; Covenants; Nonexclusive Competition; Strategic Default.;

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Cited by:
  1. Degryse, H.A. & Ioannidou, V. & Schedvin, E.L. von, 2011. "On the Non-Exclusivity of Loan Contracts: An Empirical Investigation," Discussion Paper, Tilburg University, Center for Economic Research 2011-130, Tilburg University, Center for Economic Research.
  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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