Effects of Bank Insolvency and Strategic Uncertainty on Corporate Restructuring in Transition Economies

Abstract

We study the influence of bank insolvency on corporate restructuring in a dynamic model of bank relationship. Using a poorly developed banking technology our model shows that bank insolvency can have a positive effect on firms' incentives to restructure. Due to the technology each firm faces strategic uncertainty on the restructuring decision of other firms. Restructuring has the positive externalities on restructuring incentives of other firms which may cause multiple equilibria where either all firms of a generation restructure or no firm restructures. Coordination problems can exist in each period. The optimal extent of coordination policy depends on the restructuring costs.