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The pitfalls of pledgeable cash flows : soft budget constraints, zombie lending and under-investment

Author

Listed:
  • Bernhardt, Dan

    (University of Illinois and University of Warwick)

  • Koufopoulos, Kostas

    (University of York)

  • Trigilia, Giulio

    (University of Rochester)

Abstract

We show that when borrowers are privately informed about their creditworthiness and lenders have a soft budget constraint, efficient investment requires a limit on the fraction of a firm's cash flows that can be pledged to outsiders. That is, pledgeability should neither be too low nor too high. An increase in pledgeability, or, more broadly, creditor rights, can either promote re-investment in zombie firms, which increases other firms' cost of capital, or it can lead to inesufficient underinvestment, depending on the composition of equilibrium credit demand. Thus, greater pledgeability can reduce net social surplus, and even trigger a Pareto loss. JEL Classification: G21 ; G32 ; G33 ; G38

Suggested Citation

  • Bernhardt, Dan & Koufopoulos, Kostas & Trigilia, Giulio, 2021. "The pitfalls of pledgeable cash flows : soft budget constraints, zombie lending and under-investment," The Warwick Economics Research Paper Series (TWERPS) 1327, University of Warwick, Department of Economics.
    • Handle: RePEc:wrk:warwec:1327
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    References listed on IDEAS

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    More about this item

    Keywords

    Pledgeability ; Investment efficiency ; Soft budget constraint ; Asymmetric information ; Collateral ; Zombie lending ; Under-investment;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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