Bankruptcy Litigation and Relationship Banking

Journal of Business Finance and Accounting, Forthcoming

Posted: 1 Dec 2012

Date Written: November 30, 2012

Abstract

This paper analyzes how bankruptcy litigation affects the value of relationship banking. In our model, bankruptcy courts may make type 1 errors, i.e., they may declare that an insolvent firm is solvent; and they may make type 2 errors, i.e., they may declare that a solvent firm is insolvent. Our model provides four results. First, the cost of bank debt decreases when the probability that bankruptcy courts make type 2 errors increases. Second, the value of relationship banking increases when the probability that bankruptcy courts make type 1 errors increases. Third, the cost of credit intermediation decreases when the probability that bankruptcy courts make type 2 errors increases. Fourth, the diversification mechanism does not fully solve the delegated monitoring problem.

Keywords: bankruptcy litigation, bank monitoring, cost of bank debt, cost of credit intermediation, cost of financial distress, relationship banking

JEL Classification: G21

Suggested Citation

Marini, Francois, Bankruptcy Litigation and Relationship Banking (November 30, 2012). Journal of Business Finance and Accounting, Forthcoming . Available at SSRN: https://ssrn.com/abstract=2183108

Francois Marini (Contact Author)

Université Paris IX Dauphine ( email )

Place du Maréchal de Lattre de Tassigny
75775 Paris Cedex 16
France

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