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Credit line pricing under heterogeneous risk beliefs

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  • Koussis, Nicos
  • Martzoukos, Spiros H.

Abstract

We develop a model of a firm with multistage investment options and a bank providing a commitment for financing using a credit line. We analyze differences in beliefs between equity holders and the bank about the risk of assets and show that unfavourable beliefs by the bank reduce credit line capacity and lead to underinvestment. Constraints on alternative sources of financing cause firms to heavily rely on bank credit lines even when facing unfavourable beliefs by the bank about the risk of assets. Higher loan commitment fees, charged by the bank on the unused portion of the credit line, result in an acceleration of initial investment but may reduce follow-on investment and use of the credit line. Our analysis examines the optimal choice between accelerated versus sequential investment and provides predictions on the optimal drawdown of the credit line used to finance staged investments.

Suggested Citation

  • Koussis, Nicos & Martzoukos, Spiros H., 2022. "Credit line pricing under heterogeneous risk beliefs," International Journal of Production Economics, Elsevier, vol. 243(C).
    • Handle: RePEc:eee:proeco:v:243:y:2022:i:c:s0925527321003212
    DOI: 10.1016/j.ijpe.2021.108345
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    More about this item

    Keywords

    Finance; Capital structure; Loan commitments; Default risk; Real options;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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