A Lender-Based Theory of Collateral

36 Pages Posted: 3 Nov 2008

See all articles by Roman Inderst

Roman Inderst

Goethe University Frankfurt

Holger M. Mueller

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

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Date Written: November 2004

Abstract

We offer a novel explanation for collateral based on the notion that lenders make discretionary credit decisions that are too conservative. There is no borrower asymmetricinformation or moral hazard. Rather, the problem is that if lenders cannot extract the full surplus from the projects they finance (e.g., due to credit market competition), they may reject low-, but positive-NPV projects. Collateral provides lenders with additional protection in bad states, thus improving their payoffs from projects with a relatively high likelihood of bad states and thus precisely from those projects that are inefficiently rejected. Our model is consistent with existing empirical evidence and provides new empirical predictions.

Suggested Citation

Inderst, Roman and Mueller, Holger M., A Lender-Based Theory of Collateral (November 2004). NYU Working Paper No. FIN-04-028, Available at SSRN: https://ssrn.com/abstract=1294478

Roman Inderst (Contact Author)

Goethe University Frankfurt ( email )

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Holger M. Mueller

New York University (NYU) - Department of Finance ( email )

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European Corporate Governance Institute (ECGI) ( email )

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