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The Role of Collateral in Entrepreneurial Finance

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  • Liang Han
  • Stuart Fraser
  • David J. Storey

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.

Suggested Citation

  • Liang Han & Stuart Fraser & David J. Storey, 2009. "The Role of Collateral in Entrepreneurial Finance," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(3-4), pages 424-455.
  • Handle: RePEc:bla:jbfnac:v:36:y:2009-04:i:3-4:p:424-455
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    References listed on IDEAS

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    2. Dias Duarte, Fábio & Matias Gama, Ana Paula & Paulo Esperança, José, 2017. "Collateral-based in SME lending: The role of business collateral and personal collateral in less-developed countries," Research in International Business and Finance, Elsevier, vol. 39(PA), pages 406-422.
    3. 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.
    4. Hubert Tchakoute Tchuigoua, 2015. "Capital Structure of Microfinance Institutions," Journal of Financial Services Research, Springer;Western Finance Association, vol. 47(3), pages 313-340, June.
    5. Bart M. Lambrecht, 2009. ""Discussion of" The Role of Collateral in Entrepreneurial Finance," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(3-4), pages 456-460.

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