Journal of Financial Economics Vol. 137 No. 3 2020
The paradox of pledgeability
Abstract
We develop a model in which collateral serves to protect creditors from the claims of other creditors. We find that, paradoxically, borrowers rely most on collateral when pledgeability is high. This is when taking on new debt is easy, which dilutes existing creditors. Creditors thus require collateral for protection against possible dilution by collateralized debt. There is a collateral rat race. But collateralized borrowing has a cost: it encumbers assets, constraining future borrowing and investment. There is a collateral overhang. Our results suggest that policies aimed at increasing the supply of collateral can backfire, triggering an inefficient collateral rat race. Likewise, upholding the absolute priority of secured debt can exacerbate the rat race.
- DOI
- 10.1016/j.jfineco.2019.05.005
- Volume
- 137
- Issue
- 3
- Pages
- 591-605
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref