Bargaining and exclusivity in a borrower-lender relationship

Abstract

This paper presents a stylized model of a borrower-lender relationship where funds are gradually invested in a project with uncertain return. We show that an exclusive financing relationship arises endogenously in equilibrium due to initial lender's superior information on the project's progress. The analysis also identifies a novel distortionary effect of exclusivity and the consequent loss of future rents on the ex-ante choices of the borrower. When she chooses the amount of funds to be initially invested in the project, the borrower chooses to overinvest making the future rent extraction by the initial lender as costly as possible.