Collateral, loan guarantees, and the lenders' incentives to resolve financial distress
Journal
Quarterly Review of Economics and Finance
Journal Volume
46
Journal Issue
1
Pages
1
Date Issued
2006-02-01
Author(s)
Abstract
This paper proposes that the timing for when collateral is pledged will affect the lenders' incentives to resolve financial distress. It demonstrates that, if the amount of collateral pledged in a loan contract exceeds a critical value, the borrower's project may be inefficiently liquidated once he becomes financially distressed. It also shows that a fairly priced loan guarantee provided by a third party can partially alleviate this inefficient liquidation problem. This paper predicts that riskier borrowers will pledge more collateral, which is consistent with the empirical findings of Berger and Udell [Berger, A. N., & Udell, G. F. (1990). Collateral, loan quality, and bank risk. Journal of Monetary Economics, 25, 21-42] and Leeth and Scott [Leeth, J. D., & Scott, J. A. (1989). The incidence of secured debt: evidence from the small business community. Journal of Financial and Quantitative Analysis, 24, 379-394]. © 2005 Board of Trustees of the University of Illinois. All rights reserved.
Subjects
Collateral | Financial distress | Loan guarantee | Renegotiation
Type
journal article