Bank Equity Stakes in Borrowing Firms and Financial Distress

REVIEW OF FINANCIAL STUDIES, Vol. 9 No. 3

Posted: 20 Aug 1996

See all articles by Mitchell Berlin

Mitchell Berlin

Federal Reserve Bank of Philadelphia - Research Department

Kose John

New York University (NYU) - Department of Finance

Anthony Saunders

New York University - Leonard N. Stern School of Business

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Abstract

We derive the optimal financial claim for a bank when the borrowing firm's uninformed stakeholders depend upon the bank to establish whether the firm is distressed and whether concessions by stakeholders are necessary. The bank's financial claim is designed to ensure that it cannot collude with a healthy firm's owners to seek unnecessary concessions or to collude with a distressed firm owner's to claim that the firm is healthy. To prove that a request for concessions has not come from a healthy firm/bank coalition, the bank must hold either a very small or very large equity stake when the firm enters distress. To prove that a distressed firm and the bank have not colluded to claim that the firm is healthy, the bank may need to hold equity under routine financial conditions.

JEL Classification: G00

Suggested Citation

Berlin, Mitchell and John, Kose and Saunders, Anthony, Bank Equity Stakes in Borrowing Firms and Financial Distress. REVIEW OF FINANCIAL STUDIES, Vol. 9 No. 3, Available at SSRN: https://ssrn.com/abstract=7662

Mitchell Berlin (Contact Author)

Federal Reserve Bank of Philadelphia - Research Department ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
215-574-3822 (Phone)
215-574-4364 (Fax)

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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New York, NY 10012-1126
United States
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212-995-4233 (Fax)

Anthony Saunders

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
9-190, MEC
New York, NY 10012-1126
United States
212-998-0711 (Phone)
212-995-4220 (Fax)

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