Corporate financing under moral hazard and the default risk of buyers
- 400 Downloads
We extend the theoretical model of external corporate financing to the case when the buyers of the borrowing firm may default during the financing period. In our setup there is an asymmetric information and hence moral hazard between the lender and the borrower concerning the efforts of the borrower. We define the optimal debt contract in two cases. In the symmetric case the lender and the borrower has the same information about the buyer, its probability of default. In the asymmetric case the borrower learns whether the buyer will pay or not before choosing her level of efforts. We prove that in the asymmetric case the borrowing capacity and the welfare of the society is weakly smaller than in the symmetric case. We also show that the nonnegative default risk of a buyer weakly decreases borrowing capacity compared to the case when the buyer pays for sure. However, it turns out that having a risky buyer might increase borrowing capacity and welfare.
KeywordsGame theory Moral hazard Corporate financing Trade credit
We would like to thank two anonymous referees for helpful comments.
- Beck T, Demirguc-Kunt A, Peria MSM (2007) Reaching out: access to and use of banking services across countries. J Financ Econ 85(1):234–266Google Scholar
- Biais B, Gollier C (1997) Trade credit and credit rationing. Rev Financ Stud 10(4):903–937Google Scholar
- Carbó-Valverde S, Rodríguez-Fernández F, Udell GF (2008) Bank lending, financing constraints and SME investment. Working Paper Series WP-08-04, Federal Reserve Bank of ChicagoGoogle Scholar
- Cook LD (1999) Trade credit and bank finance: financing small firms in Russia. J Bus Ventur 14(5–6): 493–518Google Scholar
- Demirguc-Kunt A, Maksimovic V (2001) Firms as financial intermediaries: evidence from trade credit data. Policy Research Working Paper Series 2696, The World BankGoogle Scholar
- Garcia-Appendini E (2007) Soft information in small business lending. EFA 2007 Ljubljana Meetings PaperGoogle Scholar
- Garcia-Appendini E, Montoriol-Garriga J (2013) Firms as liquidity providers: evidence from the 2007–2008 financial crisis. J Financ Econ 109(1):272–291Google Scholar
- Klingen C, Castillo L (2012) European Banking Coordination “Vienna” Initiative. Technical reportGoogle Scholar
- Petersen M, Rajan R (1994) The benefits of lending relationships: evidence from small business data. J Financ 49(1):3–37Google Scholar
- Tirole J (2006) The theory of corporate finance. Princeton University Press, PrincetonGoogle Scholar