Implicit Benefits and Financing

43 Pages Posted: 24 May 2019

See all articles by Franklin Allen

Franklin Allen

Imperial College London

Meijun Qian

Australian National University (ANU) - College of Business and Economics

Jing Xie

Hong Kong Polytechnic University - School of Accounting and Finance

Date Written: April 28, 2019

Abstract

Family, social and business connections create implicit benefits between borrowers and lenders. We model how these benefits influence credit allocation, cost, and renegotiation between the borrower and the lender in case of delinquency. The optimal solution illustrates that financing with implicit benefits achieves lower financing costs, higher managerial effort, and better economic outcomes for both the borrower and the lender in a competitive market or in a monopoly market where the lender maximises profit. The results reconcile the empirical evidence that financing through family, social and business networks is prevalent and often associated with good economic results even though it can be destructive in some scenarios. The model also demonstrates that, since a non-contractual, non-legal-based environment can trigger ex-post non-pecuniary costs on the borrower and lender, only politically connected (or other powerful) players survive when these costs are large. Finally, informational and financial disadvantage due to the growing size and complexity of projects, and the breakdown of relationships in modern society may explain the decline of financing in social networks despite the advantages arising from implicit benefits.

Keywords: Implicit benefits, debt financing, Social and business networks, banks

JEL Classification: G21 G23 D02

Suggested Citation

Allen, Franklin and Qian, Meijun and Xie, Jing, Implicit Benefits and Financing (April 28, 2019). Available at SSRN: https://ssrn.com/abstract=3379442 or http://dx.doi.org/10.2139/ssrn.3379442

Franklin Allen

Imperial College London ( email )

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

Meijun Qian (Contact Author)

Australian National University (ANU) - College of Business and Economics ( email )

Canberra
Australia

Jing Xie

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

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