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Bank equity stakes in borrowing firms and financial distress


  • Mitchell Berlin
  • Kose John
  • Anthony Saunders


The authors derive optimal financial claim for a bank when the borrowing firm's uninformed stakeholders depend on the bank to establish whether the firm is distressed and whether concessions by stakeholders are necessary. The bank's financial claim is designed to ensure that it cannot collude with a healthy firm's owners to seek unnecessary concessions or to collude with a distressed firm's owners to claim that the firm is healthy. To prove that a request for concessions has not come from a healthy firm/bank coalition, the bank must hold either a very small or a very large equity stake when the firm enters distress. To prove that a distressed firm and the bank have not colluded to claim that the firm is healthy, the bank may need to hold equity under routine financial conditions.

Suggested Citation

  • Mitchell Berlin & Kose John & Anthony Saunders, 1995. "Bank equity stakes in borrowing firms and financial distress," Working Papers 96-1, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:96-1

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    References listed on IDEAS

    1. Kim B. Clark & Lawrence H. Summers, 1981. "Demographic Differences in Cyclical Employment Variation," Journal of Human Resources, University of Wisconsin Press, vol. 16(1), pages 61-79.
    2. Andrew Atkeson & Robert E. Lucas, 1992. "On Efficient Distribution With Private Information," Review of Economic Studies, Oxford University Press, vol. 59(3), pages 427-453.
    3. Gomme, Paul & Greenwood, Jeremy, 1995. "On the cyclical allocation of risk," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 91-124.
    4. Diaz-Gimenez, Javier & Prescott, Edward C. & Fitzgerald, Terry & Alvarez, Fernando, 1992. "Banking in computable general equilibrium economies," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 533-559.
    5. Kydland, Finn E., 1984. "Labor-force heterogeneity and the business cycle," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 21(1), pages 173-208, January.
    6. Rios-Rull, Jose-Victor, 1994. "On the quantitative importance of market completeness," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 463-496, December.
    7. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
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    Bank loans ; Bank investments ; Investments;


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