Costs and Benefits of Creditor Concentration: An Empirical Approach

49 Pages Posted: 17 Dec 2007

Date Written: November 2007

Abstract

High concentration of creditors can have two beneficial effects on borrowers: by enhancing lenders' ability to monitor, it can reduce the likelihood of financial distress; by reducing coordination failure among creditors, it can help a distressed firm to avoid bankruptcy. However, a strong probability of debt renegotiation can exert a feedback effect on the likelihood of financial distress, by generating perverse ex-ante incentives for borrowers (soft budget constraint). Moreover, high concentration of creditors can expose borrowers to greater liquidity risks. Using Italian data on manufacturing firms, we try to separate empirically these conflicting effects. Our results show that, if we control for the soft-budget-constraint and liquidity effects, high concentration of bank credit reduces the likelihood of financial distress and liquidation, as predicted by the literature on relationship banking. But these benefits do not come without costs: enhanced monitoring is offset by the soft-budget-constraint effect and higher concentration of credit lines increases liquidity risks and thus makes both financial distress and liquidation more likely. Ultimately, the overall effect of more concentrated banking relations is a lower probability of liquidation but a higher probability of financial distress. This helps to explain the widespread existence of multiple but asymmetric banking relations in Italy.

Keywords: financial distress, liquidazione, monitoring, relationship lending, soft budget constraint

JEL Classification: G21, G33

Suggested Citation

Omiccioli, Massimo and Carmignani, Amanda, Costs and Benefits of Creditor Concentration: An Empirical Approach (November 2007). Bank of Italy Temi di Discussione (Working Paper) No. 645, Available at SSRN: https://ssrn.com/abstract=1075164 or http://dx.doi.org/10.2139/ssrn.1075164

Massimo Omiccioli (Contact Author)

Bank of Italy ( email )

Via Nazionale, 91
Roma, 00184
Italy

Amanda Carmignani

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

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