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Optimal Lending Contracts and Firm Dynamics

Review of Economic Studies Vol. 71, 2004

44 Pages Posted: 6 Sep 2001 Last revised: 29 Dec 2014

Rui A. Albuquerque

Boston College, Carroll School of Management; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Hugo A. Hopenhayn

University of California, Los Angeles (UCLA) - Department of Economics

Date Written: September 10, 2002

Abstract

We develop a general model of lending in the presence of endogenous borrowing constraints. Borrowing constraints arise because borrowers face limited liability and debt repayment cannot be perfectly enforced. In the model, the dynamics of debt are closely linked with the dynamics of borrowing constraints. In fact, borrowing constraints must satisfy a dynamic consistency requirement: The value of outstanding debt restricts current access to short term capital, but is itself determined by future access to credit. This dynamic consistency is not guaranteed in models of exogenous borrowing constraints, where the ability to raise short term capital is limited by some prespecified function of debt. We characterize the optimal default-free contract - which minimizes borrowing constraints at all histories - and derive implications for firm growth, survival, leverage, and debt maturity. The model is qualitatively consistent with stylized facts on the growth and survival of firms. Comparative statics with respect to technology and default constraints are derived.

Keywords: Financial constraints, imperfect enforcement, firm dynamics, capital structure, debt maturity

JEL Classification: D92, F34, G31, G32, G35

Suggested Citation

Albuquerque, Rui A. and Hopenhayn, Hugo A., Optimal Lending Contracts and Firm Dynamics (September 10, 2002). Review of Economic Studies Vol. 71, 2004. Available at SSRN: https://ssrn.com/abstract=273255 or http://dx.doi.org/10.2139/ssrn.273255

Rui A. Albuquerque (Contact Author)

Boston College, Carroll School of Management ( email )

140 Commonwealth Avenue
Chustnut Hill, MA 02467-3808
United States

HOME PAGE: http://ruialbuquerque.webs.com

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Hugo A. Hopenhayn

University of California, Los Angeles (UCLA) - Department of Economics ( email )

Box 951477
Los Angeles, CA 90095-1477
United States

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