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

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References

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  1. 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, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-89, October.
  2. 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.
  3. Julian R. Franks & Kjell G. Nyborg & Walter N. Torous, 1996. "A Comparison of UK, US and German Insolvency Codes," Financial Management, Financial Management Association, Financial Management Association, vol. 25(3), Fall.
  4. Ongena, Steven & Smith, David C., 2001. "The duration of bank relationships," Journal of Financial Economics, Elsevier, Elsevier, vol. 61(3), pages 449-475, September.
  5. Berger, Allen N & Udell, Gregory F, 1995. "Relationship Lending and Lines of Credit in Small Firm Finance," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 68(3), pages 351-81, July.
  6. Rajan, Raghuram & Winton, Andrew, 1995. " Covenants and Collateral as Incentives to Monitor," Journal of Finance, American Finance Association, American Finance Association, vol. 50(4), pages 1113-46, September.
  7. Bester, H., 1990. "The Role of Collateral in a Model of Debt Renegotiation," Discussion Paper, Tilburg University, Center for Economic Research 1990-60, Tilburg University, Center for Economic Research.
  8. Stanley D. Longhofer & João A. C. Santos, 1999. "The importance of bank seniority for relationship lending," Proceedings, Federal Reserve Bank of Chicago 620, Federal Reserve Bank of Chicago.
  9. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, American Finance Association, vol. 47(4), pages 1367-400, September.
  10. 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, Elsevier, vol. 27(1), pages 67-88, September.
  11. Allen N. Berger & Gregory F. Udell, 1988. "Collateral, loan quality, and bank risk," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 51, Board of Governors of the Federal Reserve System (U.S.).
  12. 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).
  13. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, Elsevier, vol. 5(2), pages 147-175, November.
  14. Steven A. Sharpe, 1989. "Asymmetric information, bank lending, and implicit contracts: a stylized model of customer relationships," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 70, Board of Governors of the Federal Reserve System (U.S.).
  15. 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).
  16. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 110(2), pages 407-43, May.
  17. 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.
  18. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(1), pages 1-25, February.
  19. Ongena, S. & Smith, D.C., 2000. "Bank relationships: A review," Open Access publications from Tilburg University urn:nbn:nl:ui:12-80678, Tilburg University.
  20. Degryse, Hans & Van Cayseele, Patrick, 2000. "Relationship Lending within a Bank-Based System: Evidence from European Small Business Data," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 9(1), pages 90-109, January.
  21. Petersen, Mitchell A & Rajan, Raghuram G, 1994. " The Benefits of Lending Relationships: Evidence from Small Business Data," Journal of Finance, American Finance Association, American Finance Association, vol. 49(1), pages 3-37, March.
  22. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, American Economic Association, vol. 75(4), pages 850-55, September.
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Citations

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Cited by:
  1. 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.
  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. Giacinto Micucci & Paola Rossi, 2010. "Debt restructuring and the role of lending technologies," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 763, Bank of Italy, Economic Research and International Relations Area.
  4. Elisabeth Müller & Volker Zimmermann, 2009. "The importance of equity finance for R&D activity," Small Business Economics, Springer, Springer, vol. 33(3), pages 303-318, October.
  5. Mueller, Elisabeth & Zimmermann, Volker, 2008. "The importance of equity finance for R&D activity: are there differences between young and oldcompanies?," ZEW Discussion Papers, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research 06-14 [rev.2], ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  6. 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.
  7. Doris Neuberger & Solvig Räthke, 2009. "Microenterprises and multiple bank relationships: The case of professionals," Small Business Economics, Springer, Springer, vol. 32(2), pages 207-229, February.
  8. John Armour, 2006. "Should we redistribute in insolvency," ESRC Centre for Business Research - Working Papers, ESRC Centre for Business Research wp319, ESRC Centre for Business Research.

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