Operational Investment and Capital Structure Under Asset-Based Lending
Vanderbilt University - Operations Management
Cornell University - Samuel Curtis Johnson Graduate School of Management
February 6, 2015
Johnson School Research Paper Series
We study the implications of asset-based lending (ABL) for the operational investment and capital structure of a borrower firm. We set up a single-period game of incomplete information between two players, a business owner and a bank. The bank moves first and offers a menu of loans to maximize its expected profit. Each loan offer is characterized by an interest rate and an inventory advance rate, which gives a credit limit that is increasing in the firm’s inventory investment. The owner then decides the inventory level and the mix of debt and equity with which to finance her firm’s operations. We analyze this game and fully characterize the firm’s operational investment and capital structure as functions of the loan terms. We then show the value of ABL under both complete and incomplete information. ABL leads to lower interest rates, inventory levels closer to the pure equity optimal solution, lending under more scenarios, and more realistic capital structure outcomes compared to pure interest rate optimization by the bank. Its benefits for the bank are higher under more adverse lending circumstance.
Number of Pages in PDF File: 40
Keywords: Inventory Management, Newsvendor Model, Operations Management-Finance Interface, Capital Structure Decisions, Bankruptcy Risk, Capital Market Frictions
Date posted: November 30, 2010 ; Last revised: February 7, 2015
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