International Finance Discussion Papers (IFDP)
January 2002
On the Sequencing of Projects, Reputation Building, and Relationship Finance
Dominik Egli, Steven Ongena, and David C. Smith
Abstract:
We study the decision an entrepreneur faces in financing multiple projects and show that relationship financing will arise endogenously in an environment where strategic defaults are likely, even when firms have access to arm's-length financing. Relationship financing allows an entrepreneur to build a private reputation for repayment that reduces the cost of financing. However, in an environment where the risk of strategic default is low, the benefits from reputation building are outweighed by holdup rents extractable by the incumbent lender. Entrepreneurs then choose to finance projects from single or multiple arm's-length lenders.
Keywords: Relationship financing, reputation building, staged financing, contract enforcement, judicial efficiency
PDF: Full Paper
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