3. Fundamental Structure of Our Model and the Result in the Case with no APR Violations

In this chapter, we explain the structure of our basic model and present the benchmark result when the APR is rigorously preserved in the liquidation of the defaulted firm. We consider the model with two periods. In the first period, the firm makes an initial efficient investment and at the end of that period the firm obtains the returns on the investment. Given such a situation, we explore whether the firm makes the inefficient additional investment by fundraising from either outside creditors or the initial creditors. The additional investment yields its returns at the end of the second period. Then, we demonstrate that if the APR is retained, no inefficiency arises in the financial contract, that is, such inefficient additional investment cannot be fundraised, but efficient initial investment can be financed by the investors. The former implies that loan evergreening never occurs, while the latter implies that a credit crunch never arises when the APR is retained. Importantly, the outside creditor cannot finance the additional investment under the APR in this setting. Thus, the initial creditor does not have any incentive to finance inefficient additional borrowing. Hence, there is no inefficiency in the lending behavior of the initial lender.