Abstract

http://ssrn.com/abstract=6804
 
 

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Covenants and Collateral as Incentives to Monitor


Raghuram G. Rajan


University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Andrew Winton


University of Minnesota - Twin Cities - Carlson School of Management


JOURNAL OF FINANCE, Vol. 50 No. 4, September 1995

Abstract:     
Although monitoring borrowers is thought to be a major function of financial institutions, the presence of other claimants reduces an institutional lender's incentive to engage in costly monitoring. Thus loan contracts must be structured so as to enhance this incentive. Short-term debt gives the lender the power to force renegotiation or liquidation when the debt matures, but this ability is not contingent on monitoring. By contrast, covenants make the loan's effective maturity, and the ability to collateralize makes the loan's effective priority, contingent on monitoring by the lender. Thus both covenants and collateral can be motivated as contractual devices that increase a lender's incentive to monitor. These results are consistent with a number of stylized facts about the use of covenants and collateral in institutional lending.

JEL Classification: G21 and G32

Accepted Paper Series


Not Available For Download

Date posted: October 13, 1995  

Suggested Citation

Rajan, Raghuram G. and Winton, Andrew, Covenants and Collateral as Incentives to Monitor. JOURNAL OF FINANCE, Vol. 50 No. 4, September 1995. Available at SSRN: http://ssrn.com/abstract=6804

Contact Information

Raghuram G. Rajan
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-4437 (Phone)
773-702-0458 (Fax)
International Monetary Fund (IMF) ( email )
700 19th Street NW
Washington, DC 20431
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
773-702-9299 (Phone)
773-702-0458 (Fax)
Andrew Winton (Contact Author)
University of Minnesota - Twin Cities - Carlson School of Management ( email )
321 19th Avenue South
Department of Finance
Minneapolis, MN 55455
United States
612-624-0589 (Phone)
612-626-1335 (Fax)
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