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The uniqueness of short-term collateralization

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Author Info
Klapper, Leora

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Abstract

The author finds evidence that lines of credit secured by accounts receivable are associated with business borrowers with a high risk of default. While an unsecured short-term loan is repaid from the borrower's future cash flow, a loan secured by accounts receivable (a unique form of"inside"collateral) is repaid from previously generated and observed sales (the borrower's trade credit terms to its customers). Consequently, lenders that secure accounts receivable are most concerned with the credit risk of the borrower's customers and the borrower's ability to continue to generate new sales. A stylizedtheoretical model demonstrates that the value of a secured line-of-credit loan in minimizing contracting costs is associated with the borrower's business risk and the quality of the borrower's customers. Empirical tests on a sample of publicly traded U.S. manufacturing firms find that firms with secured line of credit loans are observably riskier and have fewer expected growth opportunities. The author's findings suggest that observably riskier borrowers can borrow more on a secured than on an unsecured basis. The results highlight the important role of secured letters of credit in providing liquidity to risky, credit-constrained firms that might not have access to external financing through other channels.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2544.

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Date of creation: 28 Feb 2001
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Handle: RePEc:wbk:wbrwps:2544

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Related research
Keywords: Banks&Banking Reform; Economic Adjustment and Lending; Economic Theory&Research; International Terrorism&Counterterrorism; Business in Development;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Mark Carey & Mitch Post & Steven A. Sharpe, 1996. "Does corporate lending by banks and finance companies differ? Evidence on specialization in private debt contracting," Finance and Economics Discussion Series 96-25, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  2. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 841-79, November. [Downloadable!] (restricted)
    Other versions:
  3. Titman, Sheridan & Wessels, Roberto, 1988. " The Determinants of Capital Structure Choice," Journal of Finance, American Finance Association, vol. 43(1), pages 1-19, March. [Downloadable!] (restricted)
  4. Boot, Arnoud W A & Thakor, Anjan V & Udell, Gregory F, 1991. "Secured Lending and Default Risk: Equilibrium Analysis, Policy Implications and Empirical Results," Economic Journal, Royal Economic Society, vol. 101(406), pages 458-72, May. [Downloadable!] (restricted)
  5. Mark Gertler & Simon Gilchrist, 1991. "Monetary Policy, Business Cycles and the Behavior of Small Manufacturing Firms," NBER Working Papers 3892, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Bolton, Patrick & Scharfstein, David S, 1990. "A Theory of Predation Based on Agency Problems in Financial Contracting," American Economic Review, American Economic Association, vol. 80(1), pages 93-106, March. [Downloadable!] (restricted)
  7. Avery, Robert B. & Bostic, Raphael W. & Samolyk, Katherine A., 1998. "The role of personal wealth in small business finance," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 1019-1061, August. [Downloadable!] (restricted)
  8. Shleifer, Andrei & Vishny, Robert W, 1990. "Equilibrium Short Horizons of Investors and Firms," American Economic Review, American Economic Association, vol. 80(2), pages 148-53, May. [Downloadable!] (restricted)
  9. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  10. Stulz, ReneM. & Johnson, Herb, 1985. "An analysis of secured debt," Journal of Financial Economics, Elsevier, vol. 14(4), pages 501-521, December. [Downloadable!] (restricted)
  11. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October. [Downloadable!] (restricted)
  12. Fluck, Zsuzsanna, 1998. "Optimal Financial Contracting: Debt versus Outside Equity," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 11(2), pages 383-418.
  13. Barclay, Michael J & Smith, Clifford W, Jr, 1995. " The Maturity Structure of Corporate Debt," Journal of Finance, American Finance Association, vol. 50(2), pages 609-31, June. [Downloadable!] (restricted)
  14. Oliver Hart & John Moore, 1998. "Default And Renegotiation: A Dynamic Model Of Debt," The Quarterly Journal of Economics, MIT Press, vol. 113(1), pages 1-41, February. [Downloadable!] (restricted)
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  15. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September. [Downloadable!] (restricted)
  16. Berger, Allen N. & Udell, Gregory F., 1990. "Collateral, loan quality and bank risk," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 21-42, January. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Massimo Omiccioli, 2005. "Trade Credit as Collateral," Temi di discussione (Economic working papers) 553, Bank of Italy, Economic Research Department. [Downloadable!]
  2. Michael Manove & A. Jorge Padilla & Marco Pagano, 1998. "Collateral vs. Project Screening: A Model of Lazy Banks," CSEF Working Papers 10, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
    Other versions:
  3. John, Kose & Lynch, Anthony W. & Puri, Manju, 2002. "Credit Ratings, Collateral and Loan Characteristics: Implications for Yield," Research Papers 1748, Stanford University, Graduate School of Business. [Downloadable!]
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