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The Role of Collateral in Entrepreneurial Finance
Author(s) -
Han Liang,
Fraser Stuart,
Storey David J.
Publication year - 2009
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/j.1468-5957.2009.02132.x
Subject(s) - collateral , pledge , sorting , adverse selection , private information retrieval , loan , incentive , debt , business , finance , order (exchange) , economics , signalling , information asymmetry , selection (genetic algorithm) , microeconomics , computer science , computer security , artificial intelligence , political science , law , programming language
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.