The paradox of pledgeability

Jason Roderick Donaldson, Denis Gromb and Giorgia Piacentino

Journal of Financial Economics, 2020, vol. 137, issue 3, 591-605

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.

Keywords: Collateral; Secured debt; Absolute priority rule; Pledgeability (search for similar items in EconPapers)
JEL-codes: G21 G32 G33 G38 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

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Related works:
Working Paper: The Paradox of Pledgeability (2017)
Working Paper: The Paradox of Pledgeability (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:137:y:2020:i:3:p:591-605

DOI: 10.1016/j.jfineco.2019.05.005

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