🤖 AI Summary
This paper investigates firms’ choice between bank loans and corporate bonds under adverse selection. We develop a dynamic contracting model with microfoundations, centered on the key wedge that concentrated creditors (banks) exhibit higher liquidation efficiency than dispersed creditors (bondholders), capturing the fundamental distinction in default resolution: banks enforce contracts more effectively and coordinate more readily, whereas bond markets suffer from coordination frictions and weaker enforcement. Theoretically, we show that coexistence of both debt instruments arises endogenously from creditor structure differences; a sharp financing threshold governs the choice; and testable comparative statics emerge—e.g., improvements in bankruptcy efficiency or bondholder coordination increase bond issuance, narrow the credit spread between safe firms’ bonds and loans, and systematically alter default rates, collateral requirements, and debt maturity composition. All model primitives map directly to observable outcomes—including recovery rates and covenant stringency—enabling welfare decomposition for institutional design.
📝 Abstract
Firms often choose between concentrated, renegotiable bank claims and dispersed, arm's-length market debt. I develop a tractable adverse-selection model in which both financiers can take collateral, but they differ in enforcement and coordination efficiency at default. The single primitive wedge - a higher effective liquidation rate for concentrated creditors - is sufficient to generate coexistence, a sharp cutoff in the bank-bond partition, and distinctive comparative statics. A marginal improvement in bankruptcy/insolvency efficiency or bondholder coordination reallocates issuance toward bonds, compresses loan-bond pricing gaps for safe types, and shifts default incidence and collateral intensity in predictable ways. The welfare decomposition clarifies when strengthening bank enforcement reduces deadweight liquidation losses (by moving marginal types into monitored finance) versus when improving market-side coordination dominates (by accelerating dispersed-creditor resolution). The model delivers stability-relevant predictions for default rates, recovery, covenant stringency, and issuance composition around reforms that move liquidation efficiency on either side, and it provides a disciplined mapping to empirical proxies (recoveries, covenant strength, creditor dispersion).