Abstract
We investigate how the health of a relationship bank impacts upon coordination among creditors and how it affects the firm’s behavior. We show that if the relationship bank is healthy, creditors coordinate each other and the firm takes an efficient action but if it becomes financially distressed, a coordination problem arises ex post and the inefficient liquidation of the firm’s projects may occur. This coordination failure, in turn, increases the interest payments ex ante so that the firm is more likely to choose an inefficient action.
Highlights
This paper investigates how the health of a firm’s relationship bank affects the actions of firms and the coordination of creditors
We investigate how the health of a relationship bank impacts upon coordination among creditors and how it affects the firm’s behavior
We show that if the relationship bank is healthy, creditors coordinate each other and the firm takes an efficient action but if it becomes financially distressed, a coordination problem arises ex post and the inefficient liquidation of the firm’s projects may occur
Summary
This paper investigates how the health of a firm’s relationship bank affects the actions of firms and the coordination of creditors. The pros and cons of relationship banking have been discussed in many studies (Petersen and Rajan [2], Boot [3], Boot and Thakor [4], and Berger and Udell [5])1 Within these studies, it is argued that the close ties between the relationship bank and the firm potentially provide improvements in information production and monitoring, assist in the renegotiation of contracts, and increase the availability of loans to the firm. This increased ex post inefficiency reduces the ex ante efficiency of the firm’s actions This is because the higher interest payments made to the relationship bank and other creditors encourage the firm to select inefficient and riskier projects.
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