Covenants and Collateral as Incentives to Monitor

Posted: 19 Sep 1994  

Raghuram G. Rajan

University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Andrew Winton

University of Minnesota - Twin Cities - Carlson School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: July 1994

Abstract

Although monitoring borrowers is thought to be a major function of financial institutions, the presence of other claimants reduces an institutional lender's incentives to do so. Thus loan contracts must be structured to enhance the lender's incentives to monitor. Covenants make the effective maturity of a loan contingent on monitoring by the lender. The ability to secure a loan makes the effective priority of the loan contingent on monitoring by the lender. Thus both covenants and collateral can be motivated as contractual devices that increase a lender's incentive to monitor. These results are consistent with a number of stylized facts about the use of covenants and collateral in bank lending.

JEL Classification: G21

Suggested Citation

Rajan, Raghuram G. and Winton, Andrew, Covenants and Collateral as Incentives to Monitor (July 1994). Available at SSRN: https://ssrn.com/abstract=5529

Raghuram G. Rajan

University of Chicago - Booth School of Business ( email )

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International Monetary Fund (IMF) ( email )

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National Bureau of Economic Research (NBER)

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Andrew Winton (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

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Minneapolis, MN 55455
United States
612-624-0589 (Phone)
612-626-1335 (Fax)

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