Multiple Lenders, Strategic Default and Covenants
We study competition in capital markets subject to moral hazard when investors cannot prevent side trading. Perfect competition is impeded by entrepreneurs’ threat to borrow excessively from multiple lenders and to shirk. As a consequence, investors earn positive rents at equilibrium. We then analyze how investors’ ability to design financial contracts with covenants deals with this counterparty externality. We show that enlarging investors’ contracting opportunities generates a severe market failure: with covenants, market equilibria are indeterminate and Pareto ranked. Market outcomes are then determined by designing specific financial institutions. Information sharing systems restore efficiency but leave a positive rent to investors. A mechanism of investors-financed subsidies to entrepreneurs mitigates the threat of default and sustains the competitive allocation.
|Date of creation:||18 Jan 2013|
|Date of revision:||08 Aug 2014|
|Contact details of provider:|| Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma|
Web page: http://www.ceistorvergata.it
More information through EDIRC
|Order Information:|| Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma|
Web: http://www.ceistorvergata.it Email:
When requesting a correction, please mention this item's handle: RePEc:rtv:ceisrp:261. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Barbara Piazzi)
If references are entirely missing, you can add them using this form.