Real Assets and the Limits of Debt Capacity: Theory and Evidence

42 Pages Posted: 13 Apr 2012 Last revised: 25 Feb 2016

See all articles by Erasmo Giambona

Erasmo Giambona

Syracuse University - Whitman School of Management - Finance Department; James D. Kuhn Center for Real Estate

Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Timothy J. Riddiough

University of Wisconsin - School of Business - Department of Real Estate and Urban Land Economics

Date Written: February 24, 2016

Abstract

This paper considers how collateral is used to finance a going concern. The theory shows that better quality (unobservably higher-valued) firms separate themselves by committing to maintain a strong balance sheet, something lesser quality firms find too costly to do. Lower quality firms instead issue secured debt by pledging real collateral. During turbulent financial periods, however, pooling occurs in the secured debt market, which raises the average quality of firms choosing to finance in that market. Empirical results support model predictions, where we use the 1998 Russian crisis in combination with the role played by Fannie Mae and Freddie Mac for apartment REITs to highlight the relation between financing outcomes and firm type.

Keywords: Real Assets, Collateral, Limits of Debt Capacity, Fannie Mae-Freddie Mac, Apartment, Russian Crisis

JEL Classification: G31, G32

Suggested Citation

Giambona, Erasmo and Mello, Antonio S. and Riddiough, Timothy J., Real Assets and the Limits of Debt Capacity: Theory and Evidence (February 24, 2016). Available at SSRN: https://ssrn.com/abstract=2039253 or http://dx.doi.org/10.2139/ssrn.2039253

Erasmo Giambona (Contact Author)

Syracuse University - Whitman School of Management - Finance Department; James D. Kuhn Center for Real Estate ( email )

721 University Avenue
RM 640
Syracuse, NY 13244-2450
United States
315 443-4885 (Phone)

Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-263-3423 (Phone)
608-265-4195 (Fax)

Timothy J. Riddiough

University of Wisconsin - School of Business - Department of Real Estate and Urban Land Economics ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States
608-262-3531 (Phone)
608-265-2738 (Fax)

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