Multiple Lenders, Strategic Default and Covenants

57 Pages Posted: 17 Jan 2013 Last revised: 9 Aug 2014

See all articles by Andrea Attar

Andrea Attar

Toulouse School of Economics; University of Roma Tor Vergata

Catherine Casamatta

TSE-University of Toulouse 1

Arnold Chassagnon

Paris School of Economics (PSE)

Jean-Paul Decamps

University of Toulouse 1 - Toulouse School of Economics (TSE)

Date Written: June 2014

Abstract

We study competition in capital markets subject to moral hazard when investors cannot prevent side trading. Perfect competition is impeded by entrepreneurs’ threat to borrow excessively from multiple lenders and to shirk. As a consequence, investors earn positive rents at equilibrium. We then analyze how investors’ ability to design financial contracts with covenants deals with this counterparty externality. We show that enlarging investors’ contracting opportunities generates a severe market failure: with covenants, market equilibria are indeterminate and Pareto ranked. Market outcomes are then determined by designing specific financial institutions. Information sharing systems restore efficiency but leave a positive rent to investors. A mechanism of investors-financed subsidies to entrepreneurs mitigates the threat of default and sustains the competitive allocation.

Keywords: Counterparty Externality, Covenants, Nonexclusive Competition, Strategic Default.

JEL Classification: D43, D82, G33

Suggested Citation

Attar, Andrea and Casamatta, Catherine and Chassagnon, Arnold and Decamps, Jean-Paul, Multiple Lenders, Strategic Default and Covenants (June 2014). CEIS Working Paper No. 261. Available at SSRN: https://ssrn.com/abstract=2201499 or http://dx.doi.org/10.2139/ssrn.2201499

Andrea Attar (Contact Author)

Toulouse School of Economics

21, allée de Brienne
Toulouse, F 31000
France
+33 5 61128578 (Phone)

University of Roma Tor Vergata ( email )

2 Via Columbia
00100 Rome
Italy

Catherine Casamatta

TSE-University of Toulouse 1 ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

Arnold Chassagnon

Paris School of Economics (PSE) ( email )

Jean-Paul Decamps

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

21 allée de Brienne
31015 Toulouse Cedex 6
France

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