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The Political Economyof Too-Big-To-Fail

J. Atsu Amegashie

No 7403, CESifo Working Paper Series from CESifo Group Munich

Abstract: I consider a two-period model in which being “too big” is only a necessary condition for an insolvent firm to receive a government bailout because, in addition to meeting a threshold asset size, the firm must engage in a lobbying contest in order to be bailed out. The firm has a political advantage because its probability of winning the contest is increasing in its size. When the firm experiences an unfavorable price shock, I find that the balance between the size of the requisite bailout and the firm's political advantage of being "too big to fail" determines the firm’s probability of getting a bailout. Surprisingly but consistent with the US government’s differential treatment of Lehman Brothers and Bear Stearns during the 2008-2010 financial crisis, I find that a smaller firm may receive a bailout while a bigger firm will not, although both firms meet the threshold size of “too big to fail” and a firm's political advantage is increasing in its size.

Keywords: insolvency; bail-out; biased contest; political advantage; too-big-to-fail (search for similar items in EconPapers)
JEL-codes: O10 P16 P48 (search for similar items in EconPapers)
Date: 2018
New Economics Papers: this item is included in nep-bec
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