Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt

While the benefits of bank financing are relatively well understood, the cost are not. This paper argues that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's...

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Bibliographic Details
Published in:The Journal of finance (New York) 1992-09, Vol.47 (4), p.1367-1400
Main Author: RAJAN, RAGHURAM G.
Format: Article
Language:English
Subjects:
Arms length transactions
Bank credit
Bank loans
Bank ownership
Banks
Borrowing
Commercial credit
Debt
Debt repayment
Investment banking
Lenders
Loan Policies
Loans
Mathematical models
Project Financing
Short term debt
Surplus
Theory
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Summary:While the benefits of bank financing are relatively well understood, the cost are not. This paper argues that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun. The firm's portfolio choice of borrowing source and the choice of priority for its debt claims attempt to optimally circumscribe the powers of banks.
ISSN:0022-1082
1540-6261
DOI:10.1111/j.1540-6261.1992.tb04662.x