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The Design of Bank Loan Contracts

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  • Gorton, Gary
  • Kahn, James

Abstract

The unique characteristics of bank loans emerge endogenously to enhance efficiency. In a model of renegotiation between a borrower and a lender in which there is the potential for moral hazard on each side of the relationship. Firm risk is endogenous and renegotiated interest rates on the debt need not be monotone in firm risk. The initial terms of the debt are not set to price default risk but rather are set to efficiently balance bargaining power in later renegotiation. Loan pricing may be nonlinear, involving initial transfers either from the borrower to the bank or front the bank to the borrower. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Gorton, Gary & Kahn, James, 2000. "The Design of Bank Loan Contracts," Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 331-364.
  • Handle: RePEc:oup:rfinst:v:13:y:2000:i:2:p:331-64
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