Common use of Distance Clause in Contracts

Distance. Recent theoretical papers highlight the importance of distance in explaining the availability and pricing of bank loans. Lending conditions may depend on the distance between the borrower and the lender and the distance between the borrower and the closest competing bank (Table 1 summarizes the theoretical predictions). In location differentiation models (Hotelling (1929), Salop (1979)), borrowers incur distance-related transportation costs visiting their bank branch.4 Banks price uniformly if they cannot observe borrower location or are prevented from charging different prices to different borrowers. Borrowers pay the same interest rate, but the total transportation costs incurred differ, depending on the firm’s location vis-à-vis the lending bank. However, if banks observe the borrowers' location and offer interest rates based on that information, they may engage in spatial price discrimination. Banks are often informed about the borrower’s address before even granting or pricing a loan. If borrowers pay for their own transportation, as is mostly likely to be the case, a bank will charge a higher interest rate to those borrowers that are located closest to its bank branch (▇▇▇▇▇▇▇ and ▇▇▇▇▇▇ (1986)). Closer borrowers face higher total transportation costs when visiting competing banks (which are located further away than the lending bank), resulting in some market power for the lender. Similarly, a monopolist bank optimally charges a higher loan rate to close borrowers, as these borrowers incur lower total transportation costs. Consequently, discriminatory pricing based on location (and associated transportation costs) implies, for a given number of banks, a negative relationship between the loan rate and the borrower-lender distance and a similar, positive relationship between the loan rate and the distance between the borrower and the closest competing bank. Further underlining its importance, Thisse and ▇▇▇▇▇ (1988) actually show that spatial price discrimination arises endogenously, even when firms can simultaneously choose between uniform and discriminatory pricing.