Incentive Effects of Benevolent Intervention - The case of government loan guarantees

Paul K. Chaney and Anjan V. Thakor ()
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Paul K. Chaney: Vanderbilt University

Finance from EconWPA

Abstract: There has been a substantial recent growth in government loan guarantees to ailing firms in the United States. This paper investigates the potential incentive effects of this practice. Using the simplest available two-period model, it is shown that when firms know that loan guarantees may be forthcoming, they may be induced to adopt riskier investments and take on more leverage. These perverse incentive effects imply that the actual loan-guarantees-related contingent liability of the government could be much larger than suspected. Our policy recommendation is that the government either abandon the practice altogether or set up a federal agency that sells loan guarantees to all firms at prices that depend on the riskiness of the firm's assets and its leverage.

JEL-codes: G (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin
Date: 2004-11-30
Note: Type of Document - pdf; pages: 21
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http://129.3.20.41/eps/fin/papers/0411/0411047.pdf (application/pdf)

Related works:
Journal Article: Incentive effects of benevolent intervention: The case of government loan guarantees (1985)
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0411047

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