Coordination Failure with Multiple Source Lending, the Cost of Protection Against a Powerful Lender

In this paper we analyze how a firm might protect quasi-rents in an environmentof imperfect capital markets, where switching lenders is costly to the borrower, andcontracts are incomplete. As switching costs make the firm vulnerable to ex-postexploitation, it may want to diversify lending in order to prevent opportunisticrecontracting by the creditor. Multiple-source lending, however, suffers from coordinationfailure. An uncoordinated withdrawal of funds will force a financiallydistressed firm into bankruptcy even though it could have been rescued if lendersstayed firm. We show that the gains from preventing renegotiation do outweigh thecost of coordination failure if a single lender has sufficient bargaining power.