No. 273 - Monitoring, Liquidation, and Security Design

by Rafael Repullo and Javier Suarez
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By identifying the possibility of imposing a credible threat of liquidation as the key role of informed (bank) finance in a moral hazard context, and showing how credibility fails when liquidation values are low, this paper identifies the circumstances under which a mixture of informed and uninformed finance is optimal and explains why bank debt is typically secured, senior, and tightly held. In addition, we study the possibility of collusion between entrepreneurs and their informed lenders, explaining why mixed finance may not lead to a first-best level of effort and predicting that informed debt capacity will be exhausted before recourse is made to supplementary uninformed finance.

Presentation at a Seminar held by the authors at the Research Department of the Bank of Italy, 18 June 1996.

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  1. 31 July 1996
    No. 273 - Monitoring, Liquidation, and Security Design
    PDF 7 MB