Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

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ANSWERS TO CHAPTER DISCUSSION QUESTIONS 465

CHAPTER 16 BANK RELATIONSHIPS AND

COLLATERALIZATION

1. A bank relationship can prove costly to the bank if it faces a soft-budget con-

straint problem. This problem occurs when a lender in a relationship is com-

pelled to provide additional credit when the borrower faces default to protect

its previous loans. The borrower, knowing that the lender is so compelled, may

be motivated to engage in risky behaviors in which it would otherwise not en-

gage had the bank not been constrained. The bank relationship can prove costly

to the borrower if it faces a hold-up problem, where the bank’s information

monopoly can lead to undesirable outcomes such as higher borrowing rates, or

a reluctance on the borrower’s part to borrow further from the bank in order to

limit the monopolizing effect.

2. An explanation for an observed positive relation between loan maturity and rate

spreads is as follows: First, from the borrower’s perspective longer-maturity

loans are more desirable as they limit refinancing costs. Second, lenders prefer

shorter-term loans to minimize agency costs. Hence, the borrower is willing to

pay more for longer-term loans, while the lender demands greater compensa-

tion for longer-term loans. Both of these effects suggest a positive relationship

between loan maturity and rate spreads. An explanation for an observed neg-

ative relationship between loan maturity ...