Debt Enforcement And Relational Contracting
The authors examine how third-party debt enforcement affects the emergence and performance of relational contracts in credit markets. They implement an experiment with finitely repeated credit relationships in which borrowers can default. In their weak enforcement treatment defaulting borrowers can keep their funds invested. In their strong enforcement treatment defaulting borrowers have to liquidate their investment. Under weak enforcement fewer relationships emerge in which loans are extended and repaid. When such relationships do emerge they exhibit a lower credit volume than under strong enforcement.