Multiple Lenders, Strategic Default and the Role of Debt Covenants

Attar, Andrea, Casamatta, Catherine, Chassagnon, Arnold and Décamps, Jean-Paul (2019) Multiple Lenders, Strategic Default and the Role of Debt Covenants. American Economic Journal: Microeconomics, 11 (2). pp. 98-130.

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Official URL: http://tse-fr.eu/pub/33244

Abstract

We study capital markets subject to moral hazard when investors cannot prevent side trading, thereby facing an externality if firms raise funds from multiple sources. We analyze whether investors’ ability to design financial covenants that may include exclusivity clauses mitigates this externality. Following covenant violations, investors can accelerate the repayment of their loan, adjust its size, or increase interest rates. Enlarging contracting opportunities generates a severe market failure: with covenants, equilibria are indeterminate and Pareto ranked. We show that an investors-financed subsidy scheme to entrepreneurs alleviates the incentive to overborrow and sustains the competitive allocation as the unique equilibrium one.

Item Type: Article
Language: English
Date: May 2019
Refereed: Yes
Uncontrolled Keywords: Side Trading, Financial Covenants, Nonexclusive Competition, Strategic Default
JEL codes: D43 - Oligopoly and Other Forms of Market Imperfection
D82 - Asymmetric and Private Information
G33 - Bankruptcy; Liquidation
Subjects: B- ECONOMIE ET FINANCE
Divisions: TSE-R (Toulouse), TSM Research (Toulouse)
Site: UT1
Date Deposited: 21 Jan 2019 13:21
Last Modified: 26 Jul 2019 08:00
OAI ID: oai:tse-fr.eu:33244
URI: http://publications.ut-capitole.fr/id/eprint/30822

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