Retained Earnings, Interest Rates and Lending Relationship

Ariadna Dumitrescu ()

The B.E. Journal of Theoretical Economics, 2019, vol. 19, issue 1, 9

Abstract: This paper provides a moral hazard characterization of the effects of lending relationship on cost of funds. I develop a model that studies the problem of financial contracting between a bank and an entrepreneur and isolates the effect of the lending relationship on the interest rates. The main result is that a bank-entrepreneur relationship has a positive effect on the interest rates, the optimal contract specifying a decreasing sequence of interest rates. The possibility of the entrepreneur to use partially his retained earnings improves the terms of the contract between entrepreneur and lender by reducing the difference between the two interest rates.

Keywords: long-term lending relationship; moral hazard; interest rates (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1515/bejte-2017-0002

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