Bailout Stigma

Yeon-Koo Che, Chongwoo Choe and Keeyoung Rhee ()

No 26-15, Monash Economics Working Papers from Monash University, Department of Economics

Abstract: Financially distressed firms may be reluctant to accept government bailouts for fear that it may signal the weakness of their balance sheets and inhibit future financing. We study such bailout stigma via a model in which a firm must finance projects by selling legacy assets. The value of the asset is the firm’s private information, which results in inefficient trading of the asset due to standard adverse selection. Although the adverse selection problem creates a scope for government intervention, accepting a bailout can signal the toxicity of the asset, which worsens the adverse selection for the firm in the subsequent trading of its asset. We find multiple equilibrium responses to a government bailout. Bailout terms that would otherwise be acceptable may be refused due to the stigma. Even terms that are so generous as to be acceptable for firms with non-toxic assets may result in low take-up; nevertheless, such a policy could be beneficial indirectly by allowing a firm to improve its market perception by refusing the bailout. Bailout that leads to immediate market rejuvenation is welfare-dominated by an equilibrium without such market rejuvenation. A secret bailout that conceals the identity of its recipient can mitigate the stigma and can implement the (constrained) efficient outcome.

Keywords: Adverse selection; bailout stigma; secret bailout (search for similar items in EconPapers)
Pages: 60 pages
Date: 2015-04
New Economics Papers: this item is included in nep-cba and nep-cta
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Working Paper: Bailout Stigma (2023)
Working Paper: Bailout Stigma (2019)
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