The Paradox of Pledgeability

44 Pages Posted: 13 Jan 2017 Last revised: 21 Jan 2017

See all articles by Jason Donaldson

Jason Donaldson

Washington University in St. Louis

Denis Gromb

HEC Paris

Giorgia Piacentino

Columbia University

Date Written: January 1, 2017


We develop a model in which collateral serves to protect creditors from the claims of competing creditors. We find that borrowers rely most on collateral when cash flow pledgeability is high, because this is when it is easy to take on new debt, diluting existing creditors. Creditors thus require collateral for protection against being diluted. This causes a collateral rat race that results in all borrowing being collateralized. But collateralized borrowing has a cost: it encumbers assets, constraining future borrowing and investment, i.e. there is a collateral overhang. Our results suggest that the absolute priority rule, by which secured creditors are senior to unsecured creditors, may have an adverse effect — it may trigger the collateral rat race.

Suggested Citation

Donaldson, Jason and Gromb, Denis and Piacentino, Giorgia, The Paradox of Pledgeability (January 1, 2017). HEC Paris Research Paper No. FIN-2017-1185, Available at SSRN: or

Jason Donaldson (Contact Author)

Washington University in St. Louis ( email )

One Brookings Drive
Campus Box 1208
Saint Louis, MO MO 63130-4899
United States

Denis Gromb

HEC Paris

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351

Giorgia Piacentino

Columbia University ( email )

New York

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