Sharing Private Information with Customers: Strategic Default and Lender Learning

Abstract

I use a unique data set of loans to small business owners to examine whether lenders face negative externalities when they share private information with borrowers. When lenders grant debt forgiveness to borrowers, borrowers communicate that information to other borrowers, who are then more likely to strategically default on their own obligations. This strategic default contagion is economically large. When the lender doubles debt forgiveness, contagion causes the default rate to increase by 10.9% on average. Using an exogenous shock to the lender’s forgiveness policy, I further show that as the lender learns about the extent of borrower communication it tightens its debt forgiveness and origination policies to reduce information spillovers and mitigate the default contagion. Collectively, these results provide new evidence on the strategic interactions between a firm and its customers in a dynamic information environment.