Heterogeneous Multiple Bank Financing Under Uncertainty: Does it Reduce Inefficient Credit Decisions?

Small and medium-sized firms often obtain capital via a mixture of relationship and arm's-length bank lending. This paper explores the reasons for the dominance of such heterogeneous multiple bank financing. We show that the incidence of inefficient credit termination decreases in the relationship bank's information precision for firms with low expected cash-flows, but increases for firms with high expected profits. Generally, however, heterogeneous multiple bank financing leads to fewer inefficient credit decisions than both monopoly relationship lending and homogeneous multiple bank financing, provided that the relationship bank's fraction of total firm debt is not too large.