Povel, Paul
(1998)
Financial contracts, bankruptcy and product market competition.
PhD thesis, London School of Economics and Political Science.
Abstract
This thesis consists of three self–contained game–theoretic analyses of the contractual relationship between borrowers and lenders. A key element of this relation concerning their strategic variables than their opponents. Optimal contracts
for different environments are derived and studied. They include ‘bankruptcy’ games, which are designed to structure the parties’ bargaining under certain circumstances.
The first chapter questions the idea that being a unique lender to a firm is better than sharing the lender’s role. Even borrowers with poor prospects will apply for loans, if their main goal is to be financed, and re–financed if necessary. With one lender, refinancing is always provided once former loans are ‘sunk’. With two lenders, the situation may be different: inefficient negotiations have to determine how the overall loss is allocated. Some borrowers may therefore not be refinanced, and this may keep borrowers with poor prospects from applying for loans.
The second chapter extends this model by adding a timing dimension: a borrower finds out about poor prospects earlier than his lender. He can ask for refinancing, or simply ‘wait and pray’. Either ‘soft’ contracts or ‘tough’ contracts may be optimal contracts: ‘soft’ contracts treat the borrower well if he asks for refinancing, while ‘tough’ contracts don’t (and the lender will not have the option of refinancing). ‘Hybrid’ contracts are strictly worse than the two ‘pure’ types. From this we draw conclusions for the design of bankruptcy laws, and for empirical work on bankruptcy.
The third chapter analyses the interdependence of financial and production decisions. Debt contracts are frequently thought to lead to excessive risk taking — in a Cournot setup this means excessive production. At the same time, debt is a costly type of financing, which should reduce production. This conflict is analysed in a setting which allows to endogenise ‘debt’ contracts. The main result is that there is no excessive production, and financial constraints reduce output. However, for large levels of ‘inherited’ debt, it may be that output increases in the level of debt.
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