Multiple Lenders, Strategic Default and Covenants

Jean Paul Decamps, Catherine Casamatta, Arnold Chassagnon and Andrea Attar
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Jean Paul Decamps: Toulouse School of Economics
Arnold Chassagnon: Paris School of Economics

No 701, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: We study capital markets subject to moral hazard when investors cannot prevent side trading, thereby facing an externality if firms raise funds from multiple sources. We analyze whether investors’ ability to design financial covenants that may include exclusivity clauses mitigates this externality. Following covenant violations, investors can accelerate the repayment of their loan, adjust its size, or increase interest rates. Enlarging contracting opportunities generates a severe market failure: with covenants, equilibria are indeterminate and Pareto ranked. We show that an investors-financed subsidy scheme to entrepreneurs alleviates the incentive to overborrow and sustains the competitive allocation as the unique equilibrium one.

Date: 2016
New Economics Papers: this item is included in nep-cta, nep-mic and nep-sog
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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 (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:701

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