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Pledgeability, Industry Liquidity, and Financing Cycles

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  • Douglas W. Diamond
  • Yunzhi Hu
  • Raghuram G. Rajan

Abstract

Why do firms choose high debt when they anticipate high valuations, and underperform subsequently? We propose a theory of financing cycles where the importance of creditors’ control rights over cash flows (“pledgeability”) varies with industry liquidity. The market allows firms take on more debt when they anticipate higher future liquidity. However, both high anticipated liquidity and the resulting high debt limit their incentives to enhance pledgeability. This has prolonged adverse effects in a downturn. Because these effects are hard to contract upon, higher anticipated liquidity can also reduce a firm’s current access to finance.

Suggested Citation

  • Douglas W. Diamond & Yunzhi Hu & Raghuram G. Rajan, 2017. "Pledgeability, Industry Liquidity, and Financing Cycles," NBER Working Papers 23055, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:23055
    Note: CF EFG IFM ME
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    Cited by:

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    3. Cecchetti, Stephen G. & Narita, Machiko & Rawat, Umang & Sahay, Ratna, 2023. "Addressing Spillovers from Prolonged U.S. Monetary Policy Easing," Journal of Financial Stability, Elsevier, vol. 64(C).
    4. Thomas Drechsel, 2023. "Earnings-Based Borrowing Constraints and Macroeconomic Fluctuations," American Economic Journal: Macroeconomics, American Economic Association, vol. 15(2), pages 1-34, April.
    5. Diamond, Douglas W. & Hu, Yunzhi & Rajan, Raghuram G., 2022. "Liquidity, pledgeability, and the nature of lending," Journal of Financial Economics, Elsevier, vol. 143(3), pages 1275-1294.
    6. Benmelech, Efraim & Kumar, Nitish & Rajan, Raghuram, 2022. "The secured credit premium and the issuance of secured debt," Journal of Financial Economics, Elsevier, vol. 146(1), pages 143-171.
    7. Efraim Benmelech & Nitish Kumar & Raghuram Rajan, 2020. "Secured Credit Spreads," Working Papers 2020-14, Becker Friedman Institute for Research In Economics.
    8. Vladimir Asriyan & Luc Laeven & Alberto Martín, 2022. "Collateral Booms and Information Depletion [Rational Exuberance Booms]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 89(2), pages 517-555.
    9. Robert Prilmeier & René M. Stulz, 2019. "Securities Laws, Bank Monitoring, and the Choice Between Cov-lite Loans and Bonds for Highly Levered," NBER Working Papers 25467, National Bureau of Economic Research, Inc.

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    More about this item

    JEL classification:

    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E02 - Macroeconomics and Monetary Economics - - General - - - Institutions and the Macroeconomy
    • E59 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Other
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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