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Insiders and Outsiders: The Choice between Informed and Arm's‐Length Debt
Author(s) -
RAJAN RAGHURAM G.
Publication year - 1992
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1992.tb04662.x
Subject(s) - debt , portfolio , bargaining power , business , finance , power (physics) , economics , debt financing , monetary economics , microeconomics , physics , quantum mechanics
While the benefits of bank financing are relatively well understood, the costs are not. This paper argues that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun. The firm's portfolio choice of borrowing source and the choice of priority for its debt claims attempt to optimally circumscribe the powers of banks.