Lender’s Risk Incentive and Debt Forgiveness


This paper demonstrates the possibility that a lender’s risk incentive renders it difficult to conduct efficient debt renegotiation. When a lending bank has a risk incentive, the bank is not likely to make a debt concession, even though such a concession could resolve inefficiencies caused by a borrower’s risk incentive. If the debt renegotiation is refrained, then the borrowing firm chooses a value-decreasing risky project so that the collection of the loan becomes to be risky one, resulting in increase in the wealth of the lending bank’s shareholders. The lender’s risk incentive thus accelerates borrower’s risk incentive.

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