Collateral and Debt Maturity Choice. A Signaling Model

Robert Lensink and Thi Thu Tra Pham

No 05E08, Research Report from University of Groningen, Research Institute SOM (Systems, Organisations and Management)

Abstract: This paper derives optimal loan policies under asymmetric information where banks offer loan contracts of long and short duration, backed or unbacked with collateral. The main novelty of the paper is that it analyzes a setting in which high quality firms use collateral as a complementary device along with debt maturity to signal their superiority. The least-cost signaling equilibrium depends on the relative costs of the signaling devices, the difference in firm quality and the proportion of good firms in the market. Model simulations suggest a non-monotonic relationship between firm quality and debt maturity, in which high quality firms have both long-term secured debt and short-term secured or non-secured debt.

Date: 2005
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