Abstract
We study capital markets subject to moral hazard when investors cannot prevent side trading, thereby facing an externality if firms raise funds from multiple sources. We analyze whether investors’ ability to design financial covenants that may include exclusivity clauses mitigates this externality. Following covenant violations, investors can accelerate the repayment of their loan, adjust its size, or increase interest rates. Enlarging contracting opportunities generates a severe market failure: with covenants, equilibria are indeterminate and Pareto ranked. We show that an investors-financed subsidy scheme to entrepreneurs alleviates the incentive to overborrow and sustains the competitive allocation as the unique equilibrium one.
Keywords
Side Trading; Financial Covenants; Nonexclusive Competition; Strategic Default;
JEL codes
- D43: Oligopoly and Other Forms of Market Imperfection
- D82: Asymmetric and Private Information • Mechanism Design
- G33: Bankruptcy • Liquidation
Replaces
Andrea Attar, Catherine Casamatta, Arnold Chassagnon, and Jean-Paul Décamps, “Multiple Lenders, Strategic Default and the Role of Debt Covenants”, October 2010, revised October 2015.
Reference
Andrea Attar, Catherine Casamatta, Arnold Chassagnon, and Jean-Paul Décamps, “Multiple Lenders, Strategic Default and the Role of Debt Covenants”, American Economic Journal: Microeconomics, vol. 11, n. 2, May 2019, pp. 98–130.
See also
Published in
American Economic Journal: Microeconomics, vol. 11, n. 2, May 2019, pp. 98–130