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Do Zombies Rise when Interest Rates Fall? A Relationship Banking Model

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Listed:
  • Fabian Herweg
  • Maximilian Kähny

Abstract

An entrepreneur chooses a relationship bank or market finance. The advantage of bank finance is that the quality of the entrepreneur’s project is identified early, allowing to liquidate low-quality projects. The loan contract induces an efficient continuation decision if the entrepreneur has sufficient wealth. If the entrepreneur is cash constrained, the loan contract is such that the bank continues inefficient projects, i.e., zombie lending occurs. In the short run - for a given contract - a drop in the market interest rate increases zombification. The bank adapts the contract to this drop in the long run, and zombification diminishes.

Suggested Citation

  • Fabian Herweg & Maximilian Kähny, 2022. "Do Zombies Rise when Interest Rates Fall? A Relationship Banking Model," CESifo Working Paper Series 9628, CESifo.
    • Handle: RePEc:ces:ceswps:_9628
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    File URL: https://www.cesifo.org/DocDL/cesifo1_wp9628.pdf
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    More about this item

    Keywords

    evergreening; interest rates; relationship banking; Zombie firms;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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