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Bankruptcy Litigation and Relationship Banking

Authors

  • François Marini

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    • Université Paris-dauphine, Paris, France
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    • The author thanks Alessandro Riboni, Martin Walker (Editor of this journal), and an anonymous referee for many insightful comments which have led to substantial improvements in the paper. The financial support of the ANR Risk is gratefully acknowledged.


Address for correspondence: François Marini, Université Paris-dauphine, Place du Maréchal de Lattre de Tassigny, 75 775 Paris cedex 16, France.

e-mail: Francois.Marini@dauphine.fr

Abstract

This paper analyzes how bankruptcy litigation affects the value of relationship banking. In our model, bankruptcy courts may make type 1 errors, i.e., they may declare that an insolvent firm is solvent; and they may make type 2 errors, i.e., they may declare that a solvent firm is insolvent. Our model provides four results. First, the cost of bank debt decreases when the probability that bankruptcy courts make type 2 errors increases. Second, the value of relationship banking increases when the probability that bankruptcy courts make type 1 errors increases. Third, the cost of credit intermediation decreases when the probability that bankruptcy courts make type 2 errors increases. Fourth, the diversification mechanism does not fully solve the delegated monitoring problem.

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