Date of Award

1993

Document Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Department

Finance

First Advisor

William R. Lane

Abstract

This study examines the competing roles advocated for collateral in a loan contract: solving problems of adverse selection, underinvestment, incentive contracting, bankruptcy and dilution of the monitoring services provided by banks. These theories cannot be separated based upon the effect of collateral on the borrowing firm's share price. Market based evaluations for security produce: (1) a positive response for small firms in an event study, but not confirmed with multiple regression; (2) a negative association for NASDAQ listed firms with regression, but not with event study methods; and (3) no response for NYSE/Amex firms with either method although they comprise the large majority of secured loans in the study. However, these findings are consistent with an increased default risk explanation for secured debt. Logit regression indicates that secured loans can be distinguished from unsecured on the basis of financial distress. Firms with deteriorating asset values, decreasing liquidity, reduced earnings, high ratios of book-to-market value of equity and high interest expense as a percentage of cash flows receive secured loans. These results are consistent with Smith and Warner's (1979), Stulz and Johnson's (1985) and Barro's (1976) view that collateral is an effective monitoring device when firms pursue risky projects. They are also consistent with the findings of Franks and Torous (1989), Weiss (1990) and Slovin, Sushka and Waller (1992) that collateral provides the lender adequate protection under bankruptcy. This study supports the view of Slovin, Johnson and Glascock (1992) that the information provided to the market as a result of bank monitoring is limited to firms that are not highly monitored by other external agents (small firms, NASDAQ traded firms and firms that do not have investment grade bonds). The lack of a market reaction to secured loans for NYSE/Amex firms in this study provides evidence that the presence of other external monitors reduces the informational content of a security provision in a loan announcement. The employment of COMPUSTAT data to determine that financial distress is a characteristic of firms that obtain secured loans indicates that in general bankers use publicly available information to decide when a security provision should be attached to a loan contract.

Pages

220

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