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Rev Fin 2000; 13:331-364
© 2000 the Society for Financial Studies

Article

The design of bank loan contracts

G Gorton1,z and J Kahn2
1 Department of Finance, The Wharton School, University of Pennsylvania, Philadelphia, PA 19104-6367, USA
2 Federal Reserve Bank of New York, NY, USA
z Corresponding author

Abstract

The unique characteristics of bank loans emerge endogenously to enhance efficiency in a model of renegotiation between a borrower and a lender in which there is the potential for moral hazard on each side of the relationship. Firm risk is endogenous and renegotiated interest rates on the debt need not be monotone in firm risk. The initial terms of the debt are not set to price default risk but rather are set to efficiently balance bargaining power in later renegotiation. Loan pricing may be nonlinear, involving initial transfers either from the borrower to the bank or from the bank to the borrower.


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