Signalling effects of a large player in a global game of creditor coordination

Abstract

In case of multiple creditors a coordination problem can arise when the borrowing firm runs into financial distress. Even if the project’s value at maturity is enough to pay all creditors in full, some creditors may be tempted to foreclose on their loans. We develop a model of creditor coordination where a large creditor moves before a continuum of small creditors, and analyze the signalling effects of the large creditor’s investment decision on the subsequent behavior of the small creditors. The signalling effects crucially depend on the relative size of the large creditor and the relative precision of information. We derive conditions under which pure herding behavior is to be expected.