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Competitive Screening In Financial Market When Borrowers Can Recontract

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  • BEAUDRY, P.
  • POITEVIN, M.

Abstract

This paper examines how the possibility of recontracting affects the financing of projects when an entrepreneur is privately informed about the distribution of returns. We consider a game where an entrepreneur solicits initial financing for a project from competing uninformed financiers. Once the project is undertaken, but before its returns are realized, the entrepreneur can solicit additional financial contracts from competing financiers. It is assumed that these financiers can observe all previously signed contracts and that the seniority of claims is respected in the case of bankruptcy; however, the entrepreneur is never committed not to sell junior claims to competing financiers. The main results of the paper are that (1) the equilibrium is characterized by separation but nevertheless the modalities of financing depend critically on the market's priors about the project's riskiness, in particular, the amount of collateral posted by the entrepreneur varies with the market's prior perceptions about the project, (2) when the market is optimistic about the project, there exists a unique equilibrium outcome, it is separating, but the standard incentivecompatibility constraints are not binding, (3) even if the market is very pessimistic about a project's chances of success, there always exists an equilibrium in which a good project receives sufficient financing, that is, the market does not collapse due to a Lemons effect, (4) the entrepreneur's inability to commit not to recontract may be considered Pareto improving in certain situations. We discuss how the results of the paper may help explain observed financial flows.
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Suggested Citation

  • Beaudry, P. & Poitevin, M., 1990. "Competitive Screening In Financial Market When Borrowers Can Recontract," Cahiers de recherche 9035, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  • Handle: RePEc:mtl:montec:9035
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    Cited by:

    1. Dionne, Georges & Doherty, Neil A, 1994. "Adverse Selection, Commitment, and Renegotiation: Extension to and Evidence from Insurance Markets," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 209-235, April.
    2. M. Martin Boyer, 2000. "Centralizing Insurance Fraud Investigation*," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 25(2), pages 159-178, December.
    3. Joseph E. Stiglitz & Jungyoll Yun & Andrew Kosenko, 2017. "Equilibrium in a Competitive Insurance Market Under Adverse Selection with Endogenous Information," NBER Working Papers 23556, National Bureau of Economic Research, Inc.
    4. Jaynes, Gerald D., 2011. "Equilibrium and Strategic Communication in the Adverse Selection Insurance Model," Working Papers 91, Yale University, Department of Economics.
    5. M. Martin Boyer, 2001. "Project Financing when the Principal Cannot Commit," CIRANO Working Papers 2001s-29, CIRANO.
    6. Berger, Allen N. & Espinosa-Vega, Marco A. & Frame, W. Scott & Miller, Nathan H., 2011. "Why do borrowers pledge collateral? New empirical evidence on the role of asymmetric information," Journal of Financial Intermediation, Elsevier, vol. 20(1), pages 55-70, January.
    7. Keshab Bhattarai, 2015. "Financial Deepening and Economic Growth in Advanced and Emerging Economies," Review of Development Economics, Wiley Blackwell, vol. 19(1), pages 178-195, February.
    8. Gerald D. Jaynes, 2011. "Equilibrium and Strategic Communication in the Adverse Selection Insurance Model," Levine's Working Paper Archive 786969000000000243, David K. Levine.

    More about this item

    Keywords

    financial market ; game theory ; information;

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