Third-party bailouts and tough lenders
Abstract
Contrary to the standard view, we argue that bailouts can sometimes alleviate moral hazard. In our model, a lender who interacts with a sequence of borrowers may wish to cultivate a reputation for toughness, by liquidating projects following default. However, when the opportunity cost of liquidation is high and the lender cannot publicly commit to randomization, such reputation may be unsustainable. In a subset of such cases, the possibility of a third-party bailout by the government or another investor is essential for the lender to build/maintain a reputation, by reducing the lender's short-term incentives to deviate from tough play.
Fields of Study & Subjects
Housing Market and Economics
Corporate Taxation and Avoidance
Law
Economics
and Judicial Systems
Publication details
- Journal / source
- Finance research letters
- Publisher
- Elsevier BV
- Volume
- 103
- Pages
- 110154–110154
- Publication date
- 14 May 2026
- Language
- EN