Relationship Lending and Liquidation Under Imperfect Information

Eric Tassel ()
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Eric Tassel: Florida Atlantic University

Journal of Financial Services Research, 2022, vol. 61, issue 1, No 5, 165 pages

Abstract: Abstract Using a model of a competitive credit market, we study a firm’s choice between financing a production project using a transaction loan and a relationship loan. The project itself is characterized by uncertainty, with regards to both the amount and the timing of revenue. While the transaction lender enjoys a relatively lower cost of funds, the relationship lender’s advantage lies in being able to make a relatively more informed decision about the continuation value of the project in the event that the firm misses its initial payment obligation. In this setting, we make two important findings. First, we document how the firm’s optimal choice of loan type is dependent on both the liquidation value of the project and how accessible transaction credit is to distressed firms. Second, we investigate an opportunity for a lender to improve the quality of its lending relationship with the firm, and find that, under imperfect information, the lender may choose to decline certain welfare improving innovations.

Keywords: Relationship lending; Transaction credit; Liquidation (search for similar items in EconPapers)
JEL-codes: D8 G21 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s10693-020-00336-7

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