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Bankruptcy in Credit Chains

  • Cyril Monnet
  • Frederic Boissay

When firms use bank oans and trade credit,bankruptcy rules can magnify aggregate fluctuations.A priori,a rule where banks are senior is not appropriate to dampen fluctuations.It might force trade creditors into bankruptcy by triggering a ‘domino e ffect ’-when firms go bust because their clients default.Yet,banks are often senior.In this paper,we characterize the conditions under which such a rule limits the likelihood of bankruptcies.We model a credit chain where in equilibrium firms use trade credit and bank loans.Due to the credit chain,bank seniority minimizes the overall risk premium charged by trade creditors and banks.Although bank seniority magni fies the domino e ffect,we find it is optimal whenever there is a relatively high proportion of bad risks

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Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 133.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nawm04:133
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  1. Emery, Gary W., 1987. "An Optimal Financial Response to Variable Demand," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 209-225, June.
  2. Ferris, J Stephen, 1981. "A Transactions Theory of Trade Credit Use," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 243-70, May.
  3. Biais, Bruno & Gollier, Christian, 1997. "Trade Credit and Credit Rationing," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 903-37.
  4. Brennan, Michael J & Maksimovic, Vojislav & Zechner, Josef, 1988. " Vendor Financing," Journal of Finance, American Finance Association, vol. 43(5), pages 1127-41, December.
  5. Mike Burkart & Tore Ellingsen, 2002. "In-kind finance," LSE Research Online Documents on Economics 24940, London School of Economics and Political Science, LSE Library.
  6. Petersen, Mitchell A & Rajan, Raghuram G, 1997. "Trade Credit: Theories and Evidence," Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 661-91.
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