Relationship Capital and Financing Decisions

Abstract

Lending relationships matter for firm financing. In a model of debt dynamics, we study how lending relationships are formed and how they impact leverage and debt maturity choices, thereby rationalizing recent empirical findings and generating new testable predictions. In the model, lending relationships evolve through repeated interactions between firms and debt investors. Stronger lending relationships lead firms to adopt higher leverage ratios, issue longer term debt, and raise funds from non-relationship lenders when relationship quality is sufficiently high. Debt contracts involving non-relationship investors, such as syndicated loans or bonds, have longer maturity than those exclusively issued to relationship investors.

Keywords: relationship lending, capital structure, debt maturity, default

JEL Classification: G20, G32, G33