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Emergence of Captive Finance Companies and Risk Segmentation in Loan Markets: Theory and Evidence

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  • JOHN M. BARRON
  • BYUNG‐UK CHONG
  • MICHAEL E. STATEN

Abstract

A seller with some degree of market power in its product market can earn rents. In this context, there is a gain to granting credit to purchase of the product and thus to the establishment of a captive finance company. This paper examines the optimal behavior of such a durable good seller and its captive finance company. The model predicts a critical difference between the captive finance company's credit standard and that of independent lenders (“banks”), namely, that the captive finance company will adopt a more lenient credit standard. Thus, we should expect the likelihood of repayment of a captive loan to be lower than that of a bank loan, other things equal. This prediction is tested using a unique data set drawn from a major credit bureau in the United States, and the evidence supports the theoretical prediction.

Suggested Citation

  • John M. Barron & Byung‐Uk Chong & Michael E. Staten, 2008. "Emergence of Captive Finance Companies and Risk Segmentation in Loan Markets: Theory and Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(1), pages 173-192, February.
    • Handle: RePEc:wly:jmoncb:v:40:y:2008:i:1:p:173-192
    DOI: 10.1111/j.1538-4616.2008.00108.x
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    References listed on IDEAS

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