nach oben

Annals of Finance

Erschienen in:

01.11.2014 | Research Article

Legal enforcement, default and heterogeneity of project-financing contracts

verfasst von: Gabriel A. Madeira

Erschienen in: Annals of Finance | Ausgabe 4/2014

Einloggen

Aktivieren Sie unsere intelligente Suche, um passende Fachinhalte oder Patente zu finden.

search-config

KI-gestützte Suche

Aus

Abstract

This paper employs mechanism design to examine how imperfect legal enforcement impacts simultaneously the availability of credit for investment and interest rates. The analysis combines limited commitment, which encapsulates the idea that courts are imperfect, and asymmetric information about cash flows, which makes debt contracts optimal. Costly use of courts may be optimal, which differs from most limited commitment models, where punishments are merely threats, never actually applied in optimal arrangements. Paradoxically, liquidation by courts only happens in optimal arrangements when courts are imperfect. Credit constraints emerge, but even credit-constrained individuals do not borrow as much as they can. Consistent with stylized facts, wealthier individuals borrow at lower interest rates and run larger-scale enterprises. The reliability of courts has a positive effect on the scale of projects. However, its effect on interest rates is more subtle and depends on the degree of curvature of the production function.

Vorheriger Artikel Does value-at-risk encourage diversification when losses follow tempered stable or more general Lévy processes?

Nächster Artikel Runs, panics and bubbles: Diamond–Dybvig and Morris–Shin reconsidered

Sie haben noch keine Lizenz? Dann Informieren Sie sich jetzt über unsere Produkte:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

Jetzt informieren

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

Jetzt informieren

Nur mit Berechtigung zugänglich

Some examples are Acemoglu et al. (2005), La Porta et al. (1998) and Levine (2005).

The term “ bank spread” is used here to define the difference between lending interest rates and deposit interest rates, as reported by the IMF. See Laeven and Majnoni (2005).

Gennaioli (2013) focuses on the decision process within courts, and frictions that potentially generate enforcement risk. The model in the current paper simply takes some exogenous probability of enforcement failure as a reduced form strategy to consider such frictions.

This feature is typical of costly state verification models (e.g. Townsend 1979), but when randomization is allowed debt contracts are no longer optimal. Krasa and Villamil (2000) show that a combination of costly state verification and renegotiation generate debt contracts even when renegotiation is allowed. Here, debt contracts follow from the fact that cash flows are never observed, and incentive for repayment comes from a discrete threat, liquidation.

Putting it differently, the model economy is a small open economy, so the supply of credit is infinitely elastic.

As reported by Araújo and Rodrigues (2004), microdata from credit markets in Brazil (which is the country with a higher bank spread in the data set used by Laeven and Majnoni 2005) reveal that interest rates are very much dependent on the characteristics of borrowers. In their dataset, bank spreads are considerably higher for small firms and small loans.

Alternative equivalent formulation could characterize as decision variables to be defined in the contracts the discrete choice between default, voluntary liquidation and repayment, $d$, and the amount of second period transfers $p,$ and impose an alternative limited commitment constraint that any choice for this decision variable must produce at least the utility of default with zero transfers.

The derivation of these indirect value funcitons is trivial:

$$\begin{aligned} V_{2}^{r}(\theta f(k),p_{r})&= \max \limits _{s_{r}}U(\theta f(k)-p_{r} -s_{r})+\beta U(\theta f(k)+(1+r)s_{r}); \\ V_{2}^{v}(\theta f(k),p_{v})&= \max \limits _{s_{v}}U(\theta f(k)-p_{v} -s_{v})+\beta U((1+r)s_{v});\\ V_{2}^{d1}(\theta f(k),p_{d1})&= \max \limits _{s_{d1}}U(\theta f(k)-p_{d1} -s_{d1})+\beta U((1+r)s_{d1}) \hbox { and}\\ V_{2}^{d2}(\theta f(k),p_{d2})&= \max \limits _{s_{d2}}U(\theta f(k)-p_{d2} -s_{d2})+\beta U(\max \{\theta f(k),ik\}+(1+r)s_{d2}) \end{aligned}$$

Setting a value of $p_{r}$ that is so high that the choice of liquidation or default is always optimal is equivalent to assigning individuals to liquidation or default (that implies liquidation with a positive probability).

This distribution was generated from a histogram of a lognormal distribution with mean 1.1, variance 0.3 and median 1.

Although I found some examples where default did not occur.

To put it differently, the problem is solved with the additional constraint that randomization is not allowed. However, based on numerical exercises, this analysis seems to be at least a good approximation to the solution with randomization allowed. In general as I increase the number of points in the $\theta $ grid, with its distribution as an approximation of a lognormal, there is randomization for a maximum of 3 values of $\theta $, between the area in which there is repayment with probability 1 and the area where voluntary liquidation or default are chosen with probability 1. The probability of these few points decreases as the grid becomes finer.

This graph was generated with $k=1,\, b=0.8,i=0.5,c=0.2,\lambda =0.7,\theta $ has lognormal distribution with $\mu =1$ and $\sigma =1$ and $f(k)=k^{0.5}$.

The interest rates results presented in this section are borrowing interest rates, as defined in (6).

Results for different especifications of $h$ and different values of $c$ and $i$ have also been generated and are available from the author upon request. The probability of default and the interest rates increase with the variance of $\theta $, and decrease with the cost of courts $c$. Also, the scale of projects tend to be higher as the liquidation value of projects increase. In all specifications, borrowing interest rates are decreasing with wealth and scale is increasing with $\lambda $.

In the case of different specifications of $h(\theta )$, the parameters $\mu $ and $\sigma $ of the lognormal distribution are chosen so that the expected value of $\theta $ remains constant.

This prediction is consistent with results presented by Antunes et al. (2014). They construct and calibrate a general equilibrium model with financial and enforcement frictions. When comparing differences in U.S. output per capita to counterfactually high frictions consistent with Brazil, they find that intermediation and enforcement frictions can explain about 20–25 % of the output gap between the two countries.

Note that, from the structure presented in Fig. 1, $V_{2}^{d1}(y,p)=V_{2}^{v}(y,p+ik)$, and when $l=1,\, V_{2}^{d2}(y,p)=V_{2}^{v}(y,p)$.

Acemoglu, D., Johnson, S., Robinson, J.A.: Institutions as a fundamental cause of long-run growth. Handb. Econ. Growth 1, 385–472 (2005)CrossRef

Antunes, A., Cavalcanti, T., Villamil, A.: The effects of credit subsidies on development. Forthcoming, Econ. Theory (2014) doi:10.1007/s00199-014-0808-0

Araújo, A., Rodrigues, E.A.: Taxas de Juros Bancárias e Garantias Reais: uma Avaliação Preliminar com Base nos Dados da Nova Central de Risco. Central Bank of Brazil, Mimeo (2004)

Banerjee, A.V., Newman, A.F.: Occupational choice and the process of development. J. Polit. Econ. 101(2), 274–298 (1993)

Costa, A.C.A., De Mello, J.M.: Judicial risk and credit market performance: micro evidence from Brazilian payroll loans. In: Financial Markets Volatility and Performance in Emerging Markets (pp. 155–184). University of Chicago Press (2008)

De Marzo, P.M., Fishman, M.J.: Optimal long-term financial contracting. Rev. Financ. Stud. 20(6), 2079–2128 (2007)

Evans, D.S., Jovanovic, B.: An estimated model of entrepreneurial choice under liquidity constraints. J. Polit. Econ. 97, 808–827 (1989)CrossRef

Genicot, G., Ray, D.: Group formation in risk-sharing arrangements. Rev. Econ. Stud. 70(1), 87–113 (2003)CrossRef

Gennaioli, N.: Optimal contracts with enforcement risk. J. Eur. Econ. Assoc. 11.1, 59–82 (2013)CrossRef

Karlan, D., Zinman, J.: Observing unobservables: identifying information asymmetries with a consumer credit field experiment. Econometrica 77.6, 1993–2008 (2009)

Knack, S., Keefer, P.: Institutions and economic performance: cross-country tests using alternative institutional measures. Econ. Polit. 7.3, 207–227 (1995)CrossRef

Krasa, S., Villamil, A.: Optimal contracts when enforcement is a decision variable. Econometrica 68, 119–134 (2000)CrossRef

Krasa, S., Sharma, T., Villamil, A.P.: Bankruptcy and firm finance. Econ. Theory 36.2, 239–266 (2008)CrossRef

La Porta, R., Lopes-de-Silanes, F., Shleifer, A., Vishny, R.: Law and finance. J. Polit. Econ. 106(6), 1113–1155 (1998)CrossRef

Laeven, L., Majnoni, G.: Does judicial efficiency lower the cost of credit? J. Bank. Financ. 29.7, 1791–1812 (2005)CrossRef

Levine, R.: Finance and growth: theory and evidence. Handb. Econ. Growth 1, 865–934 (2005)CrossRef

Ligon, E., Thomas, J.P., Worrall, T.: Informal insurance arrangements with limited commitment: theory and evidence from village economies. Rev. Econ. Stud. 69.1, 209–244 (2002)CrossRef

Lloyd-Ellis, H., Bernhardt, D.: Enterprise inequality, and economic development. Rev. Econ. Stud. 67, 147–168 (2000)CrossRef

Mauro, P.: Corruption and growth. Q. J. Econ. 110(3), 681–712 (1995)

North, D.C.: Structure and Change in Economic History. W. W. Norton & Company (1981)

Townsend, R.M.: Optimal contracts and competitive markets with costly state verification. J. Econ. Theory 21, 1–29 (1979)CrossRef

Visaria, S.: Legal reform and loan repayment: the microeconomic impact of debt recovery tribunals in India. Am. Econ. J.: Appl. Econ. 1(3), 59–81 (2009)

von Lilienfeld-Toal, U., Mookherjee, D., Visaria, S.: The distributive impact of reforms in credit enforcement: evidence from Indian debt recovery tribunals. Econometrica 80(2), 497–558 (2012)

Titel: Legal enforcement, default and heterogeneity of project-financing contracts
verfasst von: Gabriel A. Madeira
Publikationsdatum: 01.11.2014
Verlag: Springer Berlin Heidelberg
Erschienen in: Annals of Finance / Ausgabe 4/2014
Print ISSN: 1614-2446
Elektronische ISSN: 1614-2454
DOI: https://doi.org/10.1007/s10436-014-0256-7

Springer Professional

Abstract

Bitte loggen Sie sich ein, um Zugang zu Ihrer Lizenz zu erhalten.

Sie haben noch keine Lizenz? Dann Informieren Sie sich jetzt über unsere Produkte:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Weitere Artikel der Ausgabe 4/2014

Stability of marketable payoffs with long-term assets

Runs, panics and bubbles: Diamond–Dybvig and Morris–Shin reconsidered

Financial soundness indicators and financial crisis episodes

Does value-at-risk encourage diversification when losses follow tempered stable or more general Lévy processes?