Working Paper: CEPR ID: DP17264
Authors: Franklin Allen; Meijun Qian; Jing Xie
Abstract: Social relationship and business connections create implicit benefits between borrowers and lenders. We model how implicit benefits and repayment enforcement costs influence credit allocation, cost, and renegotiation. The optimal solution illustrates that financing with implicit benefits can in many circumstances achieve lower financing costs, higher managerial effort, and better economic outcomes for both the borrower and the lender. This result explains the continuing expansion of alternative financing despite advanced formal financial intermediation, the rise of corporate insider debt, and joint ownership of debt and equity. The growing size and complexity of projects and changes in community relationships explain the expansion of bank financing.
Keywords: implicit benefits; debt financing; banks; corporate insider debt; joint equity-debt ownership; social and business networks
JEL Codes: G21; G23; D02
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| implicit benefits (J32) | lower financing costs (G32) |
| implicit benefits (J32) | higher managerial effort (M54) |
| higher managerial effort (M54) | better economic outcomes for both parties (D69) |
| lower financing costs (G32) | better economic outcomes for both parties (D69) |
| implicit benefits (J32) | increased expected payoffs for both lenders and borrowers (G21) |
| elasticity of interest rate < elasticity of effort concerning implicit benefits (H31) | expected cash payoff to the borrower increases (G51) |