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Hidden Gems and Borrowers with Dirty Little Secrets: Investment in Soft Information, Borrower Self-Selection and Competition
... Perfect competition in the banking sector ensures that banks lend to the representative entrepreneur in FT at the same rate R F as households. 19 For the representative entrepreneur in MT, repayment rates are R and R, respectively (see above). Furthermore, perfect competition leads to ...
... As a consequence, all shareholders will unanimously agree that the bank maximizes its return on equity. 19 More precisely, there exists no equilibrium in which those returns can be different and both households and banks invest a positive amount in FT. 20 Again, there is no equilibrium in which households invest in FT and in bank deposits in which R D = R F . Next, we will prove existence of equilibria when frictions and distortions are present and financial intermediation by banks is needed. ...
... Adding monitoring costs brings us closer to a model of banks engaged in all activities (screening, inspecting, etc.) related to granting bank loans and securing their repayments. Empirical evidence (Philippon [30], Gropp et al. [19]) indicates that monitoring activities represent a large part of commercial or universal banks' costs. We investigate next how such costs affect our results. ...
We examine the validity of a macroeconomic version of the Modigliani-Miller theorem. For this purpose, we develop a general equilibrium model with two production sectors, risk-averse households and financial intermediation by banks. Banks are funded by deposits and (outside) equity and monitor borrowers in lending. We impose favorable manifestations of the underlying frictions and distortions. We obtain two classes of equilibria. In the first class, the debt-equity ratio of banks is low. The first-best allocation obtains and banks' capital structure is irrelevant for welfare: a macroeconomic version of the Modigliani-Miller theorem. However, there exists a second class of equilibria with high debt-equity ratios. Banks are larger and invest more in risky technologies. Default and bailouts financed by lump sum taxation occur with positive probability and welfare is lower. Imposing minimum equity capital requirements eliminates all inefficient equilibria and guarantees the global validity of the macroeconomic version of the Modigliani-Miller theorem.
We investigate the relationship between corporate and country sustainability on the cost of bank loans. We look into 470 loan agreements signed between 2005 and 2012 with borrowers based in 28 different countries across the world and operating in all major industries. Our principal findings reveal that country sustainability, relating to both social and environmental frameworks, has a statistically and economically impactful effect on direct financing of economic activity. An increase of one unit in a country's sustainability score is associated with an average decrease in the cost of debt by 64 basis points. Our international analysis shows that the environmental dimension of a country's institutional framework is approximately twice as impactful as the social dimension, when it comes to determining the cost of corporate loans. On the other hand, we find no conclusive evidence that firm-level sustainability influences the interest rates charged to borrowing firms by banks. Our main findings survive a battery of robustness tests and additional analyses concerning subsamples, alternative sustainability metrics, and the effects of financial crisis. This article is protected by copyright. All rights reserved
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