Nº 21-46: Relationship Capital and Financing Decisions

Lending relationships matter for firm financing. In a model of debt dynamics, we study how lending relationships are formed and how they impact the joint choice of leverage and debt maturity, thereby rationalizing recent empirical findings and generating new predictions. In the model, lending relationships evolve through repeated interactions between firms and debt investors. Stronger lending relationships lead firms to adopt higher leverage ratios, issue longer term debt, and raise funds from non-relationship lenders via syndicated loans or bonds issues when relationship quality is sufficiently high. Debt contracts involving non-relationship investors have longer maturity than those exclusively issued to relationship investors.