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Competitive Screening in Financial Markets when Borrowers can Recontract

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  • Paul Beaudry
  • Michel Poitevin
Abstract
This paper examines how the possibility of recontracting affects the financing of projects when an entrepreneur is privately informed about the distribution of returns. We consider a game where an entrepreneur solicits initial financing for a project from competing uninformed financiers. Once the project is undertaken, but before its returns are realized, the entrepreneur can solicit additional financial contracts from competing financiers. It is assumed that these financiers can observe all previously signed contracts and that the seniority of claims is respected in the case of bankruptcy; however, the entrepreneur is never committed not to sell junior claims to competing financiers. The main results of the paper are that (1) the equilibrium is characterized by separation but nevertheless the modalities of financing depend critically on the market's priors about the project's riskiness, in particular, the amount of collateral posted by the entrepreneur varies with the market's prior perceptions about the project, (2) when the market is optimistic about the project, there exists a unique equilibrium outcome, it is separating, but the standard incentivecompatibility constraints are not binding, (3) even if the market is very pessimistic about a project's chances of success, there always exists an equilibrium in which a good project receives sufficient financing, that is, the market does not collapse due to a Lemons effect, (4) the entrepreneur's inability to commit not to recontract may be considered Pareto improving in certain situations. We discuss how the results of the paper may help explain observed financial flows.

Suggested Citation

  • Paul Beaudry & Michel Poitevin, 1995. "Competitive Screening in Financial Markets when Borrowers can Recontract," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 62(3), pages 401-423.
    • Handle: RePEc:oup:restud:v:62:y:1995:i:3:p:401-423.
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    File URL: http://hdl.handle.net/10.2307/2298035
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    Cited by:

    1. M. Martin Boyer, 2000. "Centralizing Insurance Fraud Investigation*," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 25(2), pages 159-178, December.
    2. Joseph E. Stiglitz & Jungyoll Yun & Andrew Kosenko, 2017. "Equilibrium in a Competitive Insurance Market Under Adverse Selection with Endogenous Information," NBER Working Papers 23556, National Bureau of Economic Research, Inc.
    3. Attar, Andrea & Mariotti, Thomas & Salanié, François, 2014. "Multiple Contracting in Insurance Markets," IDEI Working Papers 839, Institut d'Économie Industrielle (IDEI), Toulouse, revised Sep 2016.
    4. M. Martin Boyer, 2001. "Project Financing when the Principal Cannot Commit," CIRANO Working Papers 2001s-29, CIRANO.
    5. Berger, Allen N. & Espinosa-Vega, Marco A. & Frame, W. Scott & Miller, Nathan H., 2011. "Why do borrowers pledge collateral? New empirical evidence on the role of asymmetric information," Journal of Financial Intermediation, Elsevier, vol. 20(1), pages 55-70, January.
    6. Attar, Andrea & Mariotti, Thomas & Salanié, François, 2021. "Competitive Nonlinear Pricing under Adverse Selection," TSE Working Papers 21-1201, Toulouse School of Economics (TSE), revised Aug 2022.
    7. Dionne, Georges & Doherty, Neil A, 1994. "Adverse Selection, Commitment, and Renegotiation: Extension to and Evidence from Insurance Markets," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 209-235, April.
    8. Keshab Bhattarai, 2015. "Financial deepening and economic growth," Applied Economics, Taylor & Francis Journals, vol. 47(11), pages 1133-1150, March.
    9. Jaynes, Gerald D., 2011. "Equilibrium and Strategic Communication in the Adverse Selection Insurance Model," Working Papers 91, Yale University, Department of Economics.
    10. Gerald D. Jaynes, 2018. "Endogenous Beliefs and Institutional Structure in Competitive Equilibrium with Adverse Selection," Cowles Foundation Discussion Papers 2159, Cowles Foundation for Research in Economics, Yale University.
    11. Keshab Bhattarai, 2015. "Financial Deepening and Economic Growth in Advanced and Emerging Economies," Review of Development Economics, Wiley Blackwell, vol. 19(1), pages 178-195, February.
    12. Gerald D. Jaynes, 2011. "Equilibrium and Strategic Communication in the Adverse Selection Insurance Model," Levine's Working Paper Archive 786969000000000243, David K. Levine.

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