The Role of Collateral in Entrepreneurial Finance |
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| Authors: | Liang Han Stuart Fraser David J. Storey |
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| Affiliation: | The first author is from the Business School, University of Hull. The second and third authors are from CSME, Warwick Business School, Coventry. They gratefully acknowledge helpful comments from Professor Andrew Stark, an anonymous referee and conference participants at the 2008 JBFA;Capital Market Conference. The usual disclaimer applies. |
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| Abstract: | Abstract: 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. |
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| Keywords: | signalling self-selection collateral contracts |
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