Is There a Paradox of Pledgeability?
13 Pages Posted: 19 Nov 2019 Last revised: 21 Apr 2020
Date Written: December 30, 2019
We show that in the limited-commitment framework of Donaldson, Gromb and Piacentino (2019), firm value always increases in the fraction of cash flows that can be pledged as collateral. That is, pledgeability increases investment efficiency and relaxes a firm’s financing constraint. We derive this conclusion using the same con- tracts considered by the authors, and generalize the result to an arbitrary number of states. We also show that the first best can always be implemented by a non- state-contingent secured debt contract, which differs from the ones they consider.
Keywords: Collateral, Secured debt, Pledgeability
JEL Classification: G21, G32, G33, G38
Suggested Citation: Suggested Citation