Working Papers

Credit Relationships and Dynamic Credit Constraints

_{Abstract: This paper presents microeconomic evidence from the U.S. syndicated loan market showing that as a credit relationship between a lender and a borrower strengthens, borrowing is more likely to be linked to a firm’s earnings through loan covenants rather than physical assets as collateral. I rationalize this in a model with limited commitment and information asymmetry, in which heterogeneity in relationship status leads to heterogeneous borrowing constraints. In a credit relationship, access to earnings-based credit increases over time because of a learning mechanism. The lender learns about the borrower’s private information through repeated interactions and so updates its belief. This leads to a dynamic borrowing constraint for the firm, with a switch from collateral-based to earnings-based constraints as the relationship develops. Empirically, I find that the use of loan covenant, which is often linked to earnings and increases credit supply by more than collateral use, increases as the lender-borrower relationship matures. Moreover, covenants tend to replace collateral requirements in a relationship. This provides direct evidence of a dynamic credit constraint in relationship lending, and demonstrates a new channel through which relationships increase credit supply by expanding access to earnings-based contracts. Finally, the effect of relationships on access to earnings-based credits is larger for smaller, typically more informationally opaque firms, underscoring the importance of the learning mechanism.}

The Secular Decline in Interest Rates and Credit Constraints

_{Abstract: This paper examines the long-term shift in U.S. corporate loan contracting from covenant-based to collateral-based borrowing since the late 1990s, coinciding with a secular decline in interest rates. I develop a model in which banks and Nonbank Financial Institutions (NBFIs) differ in funding, regulation, and monitoring capacities. Lower interest rates diminish banks’ funding advantage, encouraging NBFI participation through loan securitization. In U.S. syndicated loan data, I show that interest rate-driven NBFI participation is associated with higher collateral incidence and lower covenant incidence. The results reveal a new channel through which monetary conditions influence the nature of firm credit constraints and shock transmissions.}

Project Heterogeneity and Financial Frictions in Long-Term Credit Relationships

_{Abstract: This paper presents a dynamic equilibrium model of long-term credit relationships, which incorporates project heterogeneity and endogenous agency frictions in addition to matching and allocation frictions. The model shows that project heterogeneity exacerbates fragility of relationships due to higher rates of termination and liquidity misallocation, thereby reducing investment. Project heterogeneity creates an amplification effect on adverse aggregate shocks in the presence of matching and allocation frictions, leading to continuous fall in aggregate economic activities and prolonged process of recovery, consistent with empirical evidence from the recent financial crisis. With endogenous agency frictions, entrepreneur-friendly covenants may favour investment when market size effect dominates.}

Early-Stage Technology Acquisitions under Market Competition and Information Asymmetry

with Xiaolan Fu, Du Liu, & Yu Xiong

_{Abstract: We develop a theoretical model to analyze investors’ and innovators’ strategies in early-stage technology acquisitions using auction theory and considering market competition on both sides and relative bargaining power in pricing. The information asymmetry in such acquisitions is captured by an independent private value environment and asymmetric valuation ranges. The model qualitatively and quantitatively reveals the negative impact of market competition on the likelihood and profit of technology acquisition. This impact can be minimized by adjusting firms’ bargaining power in determining pricing mechanisms and lowering the degree of information asymmetry. Managerial implications are discussed for investors and innovators concerning negotiation and pricing strategies facing information frictions, especially in the absence of a widely accepted valuation of early-stage technology in practice.}

Work in Progress

Dynamic Credit Constraints and Macroeconomic Fluctuations