Multiple Lenders, Strategic Default and Covenants

Andrea Attar, Catherine Casamatta, Arnold Chassagnon and Jean-Paul Décamps
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Arnold Chassagnon: Université de Tours and Paris School of Economics

No 261, CEIS Research Paper from Tor Vergata University, CEIS

Abstract: 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.

Keywords: Counterparty Externality; Covenants; Nonexclusive Competition; Strategic Default. (search for similar items in EconPapers)
JEL-codes: D43 D82 G33 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2013-01-18, Revised 2014-08-08
New Economics Papers: this item is included in nep-cta and nep-mfd
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Citations: View citations in EconPapers (7)

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Related works:
Journal Article: Multiple Lenders, Strategic Default, and Covenants (2019)
Working Paper: Multiple Lenders, Strategic Default, and Covenants (2019)
Working Paper: Multiple Lenders, Strategic Default, and Covenants (2019)
Working Paper: Multiple Lenders, Strategic Default and Covenants (2016)
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