The Role of Collateral in Entrepreneurial Finance

32 Pages Posted: 12 May 2009

See all articles by Stuart Fraser

Stuart Fraser

University of Warwick Business School

David J. Storey

Independent

Date Written: 2008-12

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.

Suggested Citation

Fraser, Stuart and Storey, David J., The Role of Collateral in Entrepreneurial Finance (2008-12). Journal of Business Finance & Accounting, Vol. 36, Issue 3-4, pp. 424-455, April/May 2009. Available at SSRN: https://ssrn.com/abstract=1400376 or http://dx.doi.org/10.1111/j.1468-5957.2009.02132.x

Stuart Fraser

University of Warwick Business School ( email )

Room B0.22
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David J. Storey

Independent

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United States

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