Waiting for Capital:Dynamic Intermediation in Illiquid Markets

Category: Finance Seminar
When: 23 November 2021
, 12:00
 - 13:15
Where: online

A firm run by risk-neutral outside shareholders that can only access the broader financialmarkets at Poisson times contracts with a continuously present intermediary with deep pocketsbut elevated cost of funds.  We derive the optimal financing contract in the presence of internalcarry  costs  of  cash  and  limited  liability:  1)  The  intermediary  provides  more  hedging  via  thefunding agreement the lower the firm’s net-cash position.  2) Even though the intermediary hasdeep pockets, some firms face endogenous liquidation risk when cash balances hit zero, whileothers are attractive enough for the intermediary to keep alive.  For the latter firms, this is doneby the intermediary building up an equity position, exited upon market access.  3) As financialmarket access improves, the set of firms facing liquidation risk shrinks as the intermediary canmore easily exit, increasing the intermediary’s willingness to provide financing.  4) The optimalcontract can be implemented via (i) a credit-line that features a state-dependent interest rateand debt-forgiveness upon financial market access for LL reason, and (ii) restricted equity thatvests upon refinancing.  5) Cash and credit-line are used simultaneously,  while equity is onlyused  when  the  firm  is  out  of  cash.   Thus,  a  pecking  order  arises.   6)  The  optimal  financingagreement is renegotiation proof.  Thus, the identity of the intermediary can switch along the equilibrium path without affecting the optimal contract.