How Do Laws and Institutions affect Recovery Rates on Collateral?

Abstract

We show that laws and institutions that strengthen creditor protection increase expected recovery rates on collateral using unique internal bank data on ex-ante appraised liquidation values and market values of assets pledged as collateral from secured loans in 16 countries. Stronger creditor protection increases expected recovery rates on movable collateral relative to immovable collateral and shifts the composition of collateral towards movable assets, which increases debt capacity through both higher loan-to-values and attenuating the creditor’s liquidation bias. Our results provide novel evidence confirming key assumptions and predictions of the financial contracting literature and shows that the recovery rate on collateral is an important first-stage mechanism through which creditor protection can improve contracting efficiency and enhance debt capacity and terms of credit.

Keywords: collateral, creditor rights, liquidation values, recovery rates

JEL Classification: K4; G2; G33