This paper investigates the relationship between competition and contract design in capital markets subject to moral hazard. We consider the stylized representation of the capital market introduced by Holmstrom and Tirole (1997, 1998), and we explicitly model competition among investors as an extensive form game. Financial contracts are taken to be non-exclusive, which guarantees that entrepreneurs can trade with several investors at a time. In such a context, we provide a full characterization of the set of equilibrium allocations and we show that the features of market equilibria crucially depend on the financial contracts made available to financiers. If lenders make use of debt contracts only, the equilibrium outcome is efficient, and it is unique when the moral hazard problem is severe. Then, the aggregate of lenders earn monopoly profits. If covenants contingent on the project’s cash-flow can be included in financial contracts, then every feasible allocations can be supported at equilibrium: market equilibria are indeterminate and Pareto-ranked. The introduction of institutional mechanisms which prevent borrowers from strategically defaulting on their loans can restore the competitive outcome as the unique equilibrium allocation.

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