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Collateral, relationship lending and financial distress: An empirical study on financial contracting

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  • Elsas, Ralf
  • Krahnen, Jan Pieter

Abstract

This paper analyses the role of collateral in loan contracting when companies are financed by multiple bank lenders and relationship lending can be present. We conjecture and empirically validate that relationship lenders, who enjoy an informational advantage over arm's-length banks, are more senior to strengthen their bargaining power in future renegotiation if borrower's face financial distress. This deters costly conflicts between lenders and fosters workout decisions by the best informed party. Consistent with our conjecture, we find that relationship lender in general have a higher probability to be collateralized, and a higher degree of collateralization (i.e. seniority). Furthermore, we show that seniority and the status of relationship lending increases the likelihood that a bank invests in a risky workout of distressed borrowers. Both findings support the view that collateral is a strategic instrument intended to influence the bargaining position of banks. Our result further suggest that seniority and relationship lending are complementary to each other. --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2002/17.

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Date of creation: 2002
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Handle: RePEc:zbw:cfswop:200217

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Related research

Keywords: relationship lending; collateral; multiple lending; loan contract design; workouts;

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References

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  1. Machauer, Achim & Weber, Martin, 1998. "Bank behavior based on internal credit ratings of borrowers," CFS Working Paper Series 1998/08, Center for Financial Studies (CFS).
  2. Berger, Allen N. & Udell, Gregory F., 1990. "Collateral, loan quality and bank risk," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 21-42, January.
  3. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 1-25, February.
  4. Machauer, Achim & Weber, Martin, 1998. "Bank behavior based on internal credit ratings of borrowers," Journal of Banking & Finance, Elsevier, vol. 22(10-11), pages 1355-1383, October.
  5. Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-89, October.
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  7. Rajan, Raghuram & Winton, Andrew, 1995. " Covenants and Collateral as Incentives to Monitor," Journal of Finance, American Finance Association, vol. 50(4), pages 1113-46, September.
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  9. Hoshi, Takeo & Kashyap, Anil & Scharfstein, David, 1990. "The role of banks in reducing the costs of financial distress in Japan," Journal of Financial Economics, Elsevier, vol. 27(1), pages 67-88, September.
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  12. Bester, H., 1990. "The Role of Collateral in a Model of Debt Renegotiation," Discussion Paper 1990-60, Tilburg University, Center for Economic Research.
  13. Franklin Allen & Douglas Gale, 1994. "A welfare comparison of intermediaries and financial markets in Germany and the U.S," Working Papers 95-3, Federal Reserve Bank of Philadelphia.
  14. Elsas, Ralf & Krahnen, Jan Pieter, 1998. "Is relationship lending special? Evidence from credit-file data in Germany," CFS Working Paper Series 1998/05, Center for Financial Studies (CFS).
  15. Manove, Michael & Padilla, A Jorge & Pagano, Marco, 2001. "Collateral versus Project Screening: A Model of Lazy Banks," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 726-44, Winter.
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Citations

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Cited by:
  1. John Armour, 2006. "Should we redistribute in insolvency," ESRC Centre for Business Research - Working Papers wp319, ESRC Centre for Business Research.
  2. Elsas, Ralf & Krahnen, Jan Pieter, 2003. "Universal Banks and Relationships with Firms," CFS Working Paper Series 2003/20, Center for Financial Studies (CFS).
  3. Neuberger, Doris & Räthke, Solvig, 2006. "Microenterprises and multiple bank relationships: Evidence from a survey among professionals," Thuenen-Series of Applied Economic Theory 61, University of Rostock, Institute of Economics.
  4. Mueller, Elisabeth & Zimmermann, Volker, 2006. "The Importance of Equity Finance for R&D Activity: Are There Differences Between Young and OldCompanies?," ZEW Discussion Papers 06-14, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  5. Müller, Elisabeth & Zimmermann, Volker, 2006. "The Importance of Equity Finance for R&D Activity – Are There Differences Between Young and Old Companies?," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 111, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  6. Doris Neuberger & Solvig Räthke, 2009. "Microenterprises and multiple bank relationships: The case of professionals," Small Business Economics, Springer, vol. 32(2), pages 207-229, February.
  7. Elisabeth Müller & Volker Zimmermann, 2009. "The importance of equity finance for R&D activity," Small Business Economics, Springer, vol. 33(3), pages 303-318, October.
  8. Giacinto Micucci & Paola Rossi, 2010. "Debt restructuring and the role of lending technologies," Temi di discussione (Economic working papers) 763, Bank of Italy, Economic Research and International Relations Area.

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