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The Role of Collateral in Entrepreneurial Finance

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  • Liang Han
  • Stuart Fraser
  • David J. Storey
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    Abstract

    Previous research has suggested collateral has the role of sorting entrepreneurs either by observed risk or by private information. In order to test these roles, this paper develops a model which incorporates a signalling process (sorting by observed risk) into the design of an incentive-compatible menu of loan contracts which works as a self-selection mechanism (sorting by private information). It then tests this Sorting by Signalling and Self-Selection Model, using the 1998 US Survey of Small Business Finances. It reports for the first time that: high type entrepreneurs are more likely to pledge collateral and pay a lower interest rate; and entrepreneurs who transfer good signals enjoy better contracts than those transferring bad signals. These findings suggest that the Sorting by Signalling and Self-Selection Model sheds more light on entrepreneurial debt finance than either the sorting-by-observed-risk or the sorting-by-private information paradigms on their own. Copyright (c) 2009 The Authors Journal compilation (c) 2009 Blackwell Publishing Ltd.

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    Bibliographic Info

    Article provided by Wiley Blackwell in its journal Journal of Business Finance & Accounting.

    Volume (Year): 36 (2009-04)
    Issue (Month): 3-4 ()
    Pages: 424-455

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    Handle: RePEc:bla:jbfnac:v:36:y:2009-04:i:3-4:p:424-455

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    Web page: http://www.blackwellpublishing.com/journal.asp?ref=0306-686X

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    Cited by:
    1. Gallurt, Jesus & Pombo, Pablo & Ramirez, Jesus & Molina, Horacio, 2012. "La asimetria de la informacion en la crisis financiera, el racionamiento del credito y la garantia como mecanismo simbiotico del sistema
      [The information asymmetry in the financial crisis, credit r
      ," MPRA Paper 39773, University Library of Munich, Germany.

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