There is no information asymmetry between borrowers and lenders, and banks can always observe whether projects succeed or fail. However, as in Jappelli et al. (2005), we assume that only part of the proceeds of the investment can be pledged against the loan. In particular, we assume that in case of success lenders can recover at most a fraction θ of output (QLi), and a fraction φ of the collateral, with θ∈[0,1] and ϕ∈[0,1]. The remaining fraction of output (1−θ) and collateral (1−φ) can be interpreted as the amount of resources required by the judicial system for its functioning. One can think of this loss as the cost of premature liquidation of the investment or, alternatively, as the cost of judicial efficiency.7 Thus, in the case that the project succeeds lenders obtain θQLi+φγiAi units of output,while in the case of failure they obtain φγiAi