The Cost of Intermediary Market Power for Distressed Borrowers

Distressed firms need urgent financing to preserve operations and avoid inefficient liquidation, but they borrow in concentrated markets shaped by existing-creditor blocking power and a small group of specialized lenders. We show that these borrowers pay exceptionally high loan spreads even after removing compensation for credit risk, liquidity risk, and non-risk loan-making costs. To quantify and decompose lender market power, we develop and estimate a dynamic game-theoretic model of distressed lending with latent demand heterogeneity, endogenous lender participation, creditor blocking power, and tacit collusion sustained by repeated syndication. Using granular facility-level data on debtor-in-possession (DIP) and highly speculative loans, we find that lender market power explains 533 bps of risk-adjusted spreads in the DIP market and 300 bps in the highly speculative loan market, including about 140 bps from tacit collusion in each market. Smaller borrowers are especially vulnerable because their weaker bargaining positions and less elastic demand strengthen specialized lenders' incentives to collude. Lender market power is therefore a major source of financial distress costs, reducing survival-critical liquidity by 16--20\% and thereby worsening asset-value destruction.