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The Commitment Problem of Secured Lending

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Abstract

The paper investigates optimal financial contracts when investment in pledgeable assets is endogenous and not observable to financiers. In a setting with uncertainty, two inputs with different collateral value and investment unobservability, we show that a firm-bank secured credit contract is time-inconsistent: Once credit has been granted, the entrepreneur has an ex-post incentive to alter the input combination towards the input with low collateral value and higher productivity, thus jeopardizing total bank revenues. Anticipating the entrepreneur's opportunism, the bank offers a non-collateralized credit contract, thereby reducing the surplus of the venture. One way for the firm to commit to the contract terms is to purchase inputs on credit and pledge them to the supplier in case of default. Observing the input investment and having a stake in the bad state, the supplier acts as a guarantor that the input combination specified in the bank contract will be actually purchased and that the entrepreneur will stick to the contract terms. The paper concludes that: (1) Buying inputs on account facilitates the access to collateralized bank financing; (2) Firms using both trade credit and collateralized bank finance invest more in pledgeable assets than firms only using uncollateralized bank credit. Our results are robust to the possibility of collusion between entrepreneur and supplier.

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  • Daniela Fabbri & Annamaria Menichini, 2012. "The Commitment Problem of Secured Lending," CSEF Working Papers 318, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    • Handle: RePEc:sef:csefwp:318
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    2. Jinlong Chen & Weipeng Wu & Yiqun Zhuang, 2023. "Impact of Digital Supply Chain on Sustainable Trade Credit Provision: Evidence from Chinese Listed Companies," Sustainability, MDPI, vol. 15(15), pages 1-23, August.
    3. Jiri Chod & Nikolaos Trichakis & Gerry Tsoukalas & Henry Aspegren & Mark Weber, 2020. "On the Financing Benefits of Supply Chain Transparency and Blockchain Adoption," Management Science, INFORMS, vol. 66(10), pages 4378-4396, October.
    4. ABATEMARCO, Antonio & BENNARDO, Alberto, 2018. "Communication Costs and Incentives to Acquire Soft and Hard Knowledge," CELPE Discussion Papers 157, CELPE - CEnter for Labor and Political Economics, University of Salerno, Italy.
    5. Sung, Hao-Chang & Ho, Shirley J., 2020. "Supply chain finance and impacts of consumers’ sustainability awareness," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    6. Cheung, Adrian (Waikong) & Pok, Wee Ching, 2019. "Corporate social responsibility and provision of trade credit," Journal of Contemporary Accounting and Economics, Elsevier, vol. 15(3).

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    More about this item

    Keywords

    collateral; commitment; trade credit; bank financing;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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