Why Do Borrowers Pledge Collateral? New Empirical Evidence on the Role of Asymmetric Information

Allen N. Berger, Marco A. Espinosa-Vega, W. Scott Frame, and Nathan H. Miller
Working Paper 2006-29a
Revised July 2007

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An important theoretical literature motivates collateral as a mechanism that mitigates adverse selection, credit rationing, and other inefficiencies that arise when borrowers hold ex ante private information. There is no clear empirical evidence regarding the central implication of this literature—that a reduction in asymmetric information reduces the incidence of collateral. We exploit exogenous variation in lender information related to the adoption of an information technology that reduces ex ante private information, and compare collateral outcomes before and after adoption. Our results are consistent with this central implication of the private-information models and support the empirical importance of this theory.

JEL classification: G21, D82, G32, G38

Key words: collateral, asymmetric information, banks, small business, credit scoring

The authors thank Lamont Black, Laurent Weill, and participants at presentations at the Financial Management Association Barcelona conference, and the University of Texas at Arlington for helpful comments. Pam Frisbee, Phil Ostromogolsky, and Shalini Patel provided outstanding research assistance. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, the International Monetary Fund, or their staffs. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Allen N. Berger, Board of Governors of the Federal Reserve System, Wharton Financial Institutions Center, aberger@frb.gov; Marco A. Espinosa-Vega, International Monetary Fund, mespinosa@imf.org; W. Scott Frame, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., GA 303090-4470, scott.frame@atl.frb.org; or Nathan H. Miller, University of California, Berkeley, miller@uclink.berkeley.edu.

For further information, contact the Public Affairs Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470, 404-498-8020.