Non-exclusive Credit Market Competition and Firm Liquidity

Abstract

This paper studies the effect of non-exclusive competition on liquidity provision in a generic financial intermediation setting. We introduce non-exclusive contracting to the baseline model in Holmstrom and Tirole (1998). In this baseline setting, a firm needs to obtain a share of its project's proceedings because of a moral hazard problem. Banks are willing to provide an up-front investment and a finite liquidity facility in exchange for part of the project's proceedings. If a firm can privately attract credit lines from diff erent banks, outside banks can free-ride upon liquidity provided by an incumbent bank, in exchange for the firm's original share. This leads to the exclusive competition outcome no longer being sustained. In equilibrium, an incumbent bank can ward off outside lenders by offering unlimited liquidity support.