Bank's skin-in-the-game and hold-up by illiquid firms: strategic bargaining, dynamic inconsistency and credit constraints
Résumé
The loan literature analyzes the hold-up problem from the bank monopolistic information perspective, but if only the firm can fully repay the bank, the loan relationship is actually a bilateral monopoly. Then, if a firm borrows short to finance a long-term project, non-cooperative bargaining occurs at loan renewal. If, regardless of the firm's second-period quality, the perfect equilibrium partition derived from this bargaining grants the bank less than the break-even condition, she declines to lend ex-ante.
That is, expected hold-up by the firm induces credit constraints. If the firm gets more by defaulting than by borrowing from another bank, the initial bank cannot break even by filing for the firm bankruptcy; that is, the bank has a weak outside option. Then, even if this option is binding, the previous credit constraints result holds. Such hold-up by illiquid firms provides a new foundation for long-term lending to finance long-term projects.
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