We study capital markets in which investors compete by designing financial contracts to control an entrepreneur's ability to side trade and default on multiple loans. We show that covenants may have anticompetitive effects: in particular, they prevent investors from providing additional funds and reduce the entrepreneur's investment capacity. As a result, a large number of inefficient allocations is supported at equilibrium. We propose a subsidy mechanism similar to guarantee funds in financial markets that efficiently controls the entrepreneur's side trading and sustains the competitive allocation as the unique equilibrium one.
Attar, Andrea, Catherine Casamatta, Arnold Chassagnon, and Jean-Paul Décamps.
"Multiple Lenders, Strategic Default, and Covenants."
American Economic Journal: Microeconomics,
Firm Behavior: Theory
Asymmetric and Private Information; Mechanism Design
Economics of Contract: Theory
Banks; Depository Institutions; Micro Finance Institutions; Mortgages
Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill