APPLIED ECONOMICS AND POLICY


Te Imitation Game: How Encouraging Renegotiation


Makes Good Borrowers Bad Review of Financial Studies, 37, 12, December 2024


SEAN FLYNN ASSISTANT PROFESSOR


Cornell Peter and Stephanie Nolan School of Hotel Administration


Cornell SC Johnson College of Business Cornell University


Co-authors • Sean Flynn, Assistant Professor, Cornell Peter and Stephanie Nolan School of Hotel


• Alexei Tchistyi


Administration, Cornell SC Johnson College of Business, Cornell University Associate Professor, Cornell Peter and Stephanie Nolan School of


Hotel Administration, Cornell SC Johnson College of Business, Cornell University • Andra Ghent, Eccles School of Business, University of Utah


Summary Principal modifications for distressed real estate loans may be preferable to


foreclosures in some instances because of deadweight foreclosure costs. How- ever, principal modifications may also increase the risk of borrowers on other loans strategically defaulting in an attempt to extract similar modifications.


ALEXEI TCHISTYI ASSOCIATE PROFESSOR


Cornell Peter and Stephanie Nolan School of Hotel Administration


Cornell SC Johnson College of Business Cornell University


In this study, the authors show that commercial mortgage borrowers behave opportunistically to attempt to obtain principal reductions. Tey develp a model in which lenders cannot perfectly observe borrowers’ use values and renegotiation is costly, and then exploit a tax rule change that redued the cost of renegotiation. Consistent with the model predictions, borrowers with high private use values of the property are more likely to transfer into special ser- vicing when lenders have a higher capacity to negotiate principal reductions after the rule change. Tese results suggest adverse consequences of principal forgiveness for lenders.


For borrowers to be able to behave opportunistically to the disadvantage of lenders, there must be asymmetric information between borrowers and lenders such that financially healthy borrowers can imitate unhealthy ones; lenders must not be able to observe borrowers’ true willingness and ability to pay.


LINK TO PAPER LINK TO SEAN FLYNN VIDEO


CONTENTS TO MAIN


| RESEARCH WITH IMPACT: CORNELL SC JOHNSON COLLEGE OF BUSINESS • 2024 EDITION


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