Emergence of Captive Finance Companies and Risk Segmentation in Loan Markets: Theory and Evidence

John Barron (), Byung-Uk Chong and Michael E. Staten

Journal of Money, Credit and Banking, 2008, vol. 40, issue 1, 173-192

Abstract: A seller with some degree of market power in its product market can earn rents. In this context, there is a gain to granting credit to purchase of the product and thus to the establishment of a captive finance company. This paper examines the optimal behavior of such a durable good seller and its captive finance company. The model predicts a critical difference between the captive finance company's credit standard and that of independent lenders ("banks"), namely, that the captive finance company will adopt a more lenient credit standard. Thus, we should expect the likelihood of repayment of a captive loan to be lower than that of a bank loan, other things equal. This prediction is tested using a unique data set drawn from a major credit bureau in the United States, and the evidence supports the theoretical prediction. Copyright 2008 The Ohio State University.

Date: 2008
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Persistent link: https://EconPapers.repec.org/RePEc:mcb:jmoncb:v:40:y:2008:i:1:p:173-192

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