Informational Paradox of external financing

In this paperI develop a model for small and medium enterprises’ external financing. I concentrate on a situation where a firm offering trade credit to his customer applies for a credit at a bank. The effect of a defaulting customer on the borrowing capacity of the supplier has not yet been covered by the litterature. In a contract theroretical more generaly, in a game theoretical framework, there is an informational asymmetry between the lender and the borrower on the credit worthyness of the entrepreneur. In this model, the informational asymmetry leads to moral hazard which results in credit rationing.An optimal contract considering also a possibly defaulting customer generates additional credit rationing. The paper develops two subcases: in the first one the borrower has informational advantage on his customer compared to the creditor, in the second there is not any informatioanl advantage related to the customer. The results show an informational paradox, the informational advantage of the borrower reduces the volume of credit he can receive, while the informational symmetry leads to a higher borrowing capacity.The model decribes a typical situation on the Hungarian market. Banks provide a low volume of credit to SME because the firms’s financial statements and their relationship with their customers is not opac. So the informational disadvantage induces the bank to offer a low level of credit even if the net present value of the financed projects is highly positive.