The Impact of Bank Health on Coordination among Creditors

Abstract

We investigate how the health of a relationship bank impacts upon coordination among creditors and how it affects the firm ’ s behavior. We show that if the relationship bank is healthy, creditors coordinate each other and the firm takes an efficient action but if it becomes financially distressed, a coordination problem arises ex post and the inefficient liquidation of the firm ’ s projects may occur. This coordination failure, in turn, increases the interest payments ex ante so that the firm is more likely to choose an inefficient action.