A Theory of Reverse Asset Substitution

41 Pages Posted: 20 Nov 2011 Last revised: 1 Dec 2012

Date Written: March 14, 2012

Abstract

This paper studies Reverse Asset Substitution (RAS), an agency problem in which banks place investment and borrowing restrictions on firms as part of a strategy to extract surplus from the firms over multiple periods. RAS arises for firms that cannot access public debt markets due to agency problems and cannot commit to a lending bank for a long relationship. RAS provides a constrained optimal lending solution to ensure banks can lend to firms despite this limited commitment problem. Under RAS, the restrictions imposed by banks commit the firms to having a prolonged lending relationship. RAS reduces a firm’s investment and leverage compared to the case in which firms can commit to a lending relationship with the bank.

Keywords: Reverse Asset Substitution, Banking

JEL Classification: G21, G31, G32, G33, D21, D82

Suggested Citation

Allen, Franklin and Chakraborty, Indraneel, A Theory of Reverse Asset Substitution (March 14, 2012). Available at SSRN: https://ssrn.com/abstract=1019383 or http://dx.doi.org/10.2139/ssrn.1019383

Franklin Allen

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Indraneel Chakraborty (Contact Author)

University of Miami ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States
312-208-1283 (Phone)

HOME PAGE: http://sites.google.com/site/chakraborty/

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