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Board of Governors of the Federal Reserve System (U.S.)
International Finance Discussion Papers
On the sequencing of projects, reputation building, and relationship finance
Dominik Egli
Steven Ongena
David C. Smith
Abstract

We study the decision an entrepreneur faces in financing multiple projects and show that relationship financing will arise endogenously in an environment where strategic defaults are likely, even when firms have access to arm's-length financing. Relationship financing allows an entrepreneur to build a private reputation for repayment that reduces the cost of financing. However, in an environment where the risk of strategic default is low, the benefits from reputation building are outweighed by holdup rents extractable by the incumbent lender. Entrepreneurs then choose to finance projects from single or multiple arm's-length lenders.


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Dominik Egli & Steven Ongena & David C. Smith, On the sequencing of projects, reputation building, and relationship finance, Board of Governors of the Federal Reserve System (U.S.), International Finance Discussion Papers 718, 2002.
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Keywords: Corporations - Finance
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