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Multiple Lenders, Strategic Default, and Covenants

  • Andrea Attar
  • Catherine Casamatta
  • Arnold Chassagnon
  • Jean-Paul Décamps
American Economic Journal: Microeconomics
vol. 11, no. 2, May 2019
(pp. 98-130)
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Abstract

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.

Citation

Attar, Andrea, Catherine Casamatta, Arnold Chassagnon, and Jean-Paul Décamps. 2019. "Multiple Lenders, Strategic Default, and Covenants." American Economic Journal: Microeconomics, 11 (2): 98-130. DOI: 10.1257/mic.20170189

Additional Materials

JEL Classification

  • D21 Firm Behavior: Theory
  • D82 Asymmetric and Private Information; Mechanism Design
  • D86 Economics of Contract: Theory
  • G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
  • G32 Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
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