Firm Risk and Collateralized Asset Choice in Small Business Bank Lending: Theory and Evidence

Abstract

Data show that collateral is ubiquitous in small business (bank-sourced) loan financing. The asset used as collateral can be either a business or a personal asset. An 'incomplete financial contracting' model shows that the use of a personal asset as collateral can be either increasing or decreasing in firm risk. The second part of this prediction is the opposite of that for collateral use more generally (that is, ignoring type of asset). The prediction is supported when tested against data on small business financing. The data also weakly support the model's further predictions that the likelihood of the use of a personal asset as collateral is independent of both firm size and loan size.