Reputation, Renegotiation, and the Choice between Bank Loans and Publicly Traded Debt

Posted: 10 May 2000

See all articles by Thomas J. Chemmanur

Thomas J. Chemmanur

Boston College - Carroll School of Management

Paolo Fulghieri

University of North Carolina Kenan-Flagler Business School; European Corporate Governance Institute (ECGI)

Abstract

We model firms' choice between bank loans and publicly traded debt, allowing for debt-renegotiation in the event of financial distress. Entrepreneurs, with private information about their probability of financial distress, borrow from banks (multi-period players) or issue bonds to implement projects. If a firm is in financial distress, lenders devote a certain amount of resources (unobservable to entrepreneurs) to evaluate whether to liquidate the firm or to renegotiate its debt. We demonstrate that banks' desire to acquire a reputation for making the "right" renegotiation versus liquidation decision provides them an endogenous incentive to devote a larger amount of resources than bondholders toward such evaluation. In equilibrium, bank loans dominate bonds from the point of view of minimizing inefficient liquidation; however, firms with a lower probability of financial distress choose bonds over bank loans.

JEL Classification: G32

Suggested Citation

Chemmanur, Thomas J. and Fulghieri, Paolo, Reputation, Renegotiation, and the Choice between Bank Loans and Publicly Traded Debt. REVIEW OF FINANCIAL STUDIES Volume 7, Number 3, 1994. Available at SSRN: https://ssrn.com/abstract=5340

Thomas J. Chemmanur (Contact Author)

Boston College - Carroll School of Management ( email )

Finance Department, 436 Fulton Hall
Carroll School of Management, Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://https://www2.bc.edu/thomas-chemmanur/

Paolo Fulghieri

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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