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1、 lichiro uesugi Role of collateral and personal guarantees in relationship lending: evidence from Japans SME loan market 1 Introduction A key issue of interest in the recent literature on financial intermediation has been the role of relationship lending. Relationship lending is particularly common

2、in the case of small business lending, because small businesses typically rely on bank loans for a substantial part of their financing needs but also tend to be informationally opaque. An important issue in this context is the use of collateral, which is a common feature of loan contracts between sm

3、all firms and banks around the world, and a number of theoretical and empirical studies have examined why it is so widespread and how it relates to the incentives for borrowers and lenders and the borrower-lender relationship. For instance, it has been argued that in the presence of information asym

4、metries between creditors and borrowers, collateral may mitigate the problem of adverse selection （Bester, 1985; 1987） and/or the problem of moral hazard （Bester, 1994; Boot, Thakor, and Udell, 1991）. Collateral also affects the incentives of creditors, who will use it either as a substitute for （Ma

5、nove, Padilla, and Pagano, 2001） or complement to （Rajan and Winton, 1995; Boot 2000; Longhofer and Santos, 2000） screening and monitoring efforts. Another aspect of collateral that studies have concentrated on is that its presence may depend on the length and intimacy of the relationship between cr

6、editors and borrowers （Boot, 2000; Boot and Thakor, 1994; Sharpe, 1990）. Existing empirical research has yet to reach decisive conclusions about the nature of these relationships. This paper seeks to contribute to the existing literature on collateral using a unique firm-level data set of the small

7、and medium sized enterprise （SME） loan market in Japan. Explicitly differentiating physical collateral （such as real estate） and personal guarantees by business representatives, we investigate how the use of collateral and personal guarantees affects the incentives of borrowers, lenders, and the rel

8、ationship between them. More specifically, we examine the following three issues. First, we examine whether riskier borrowers are more likely to be required to provide collateral or personal guarantees. Second, we investigate how collateral and personal guarantees affect banks monitoring of borrower

9、s. Third, we examine the 1 correlation between the use of collateral and personal guarantees on the one hand and the closeness of borrower-lender relationships on the other. The data set we employ is based mainly on the “Survey of the Financial Environment” （SFE） conducted by the Small and Medium En

10、terprise Agency of Japan in October 2002. In order to focus on firms that mostly depend on bank loans for their financing, we limit the sample to firms satisfying the legal definition of an SME in Japan. We then combine the SFE data for each SME with information on their main bank obtained from the

11、banks financial statements in order to control for lender characteristics as well. Furthermore, to control for the effect of government credit guarantees on collateral and personal guarantees, in the main analysis of this paper we exclude from the sample all firms that enjoyed any form of government

12、 credit guarantee. As a result of this screening process, we end up with a sample of 1,702 firms. Our main findings can be summarized as follows. We find that firms riskiness does not have a significant effect on the likelihood that collateral is used. Thus, we cannot find firm evidence that the use

13、 of collateral mitigates moral hazard. We find, however, that banks whose claims are collateralized monitor borrowers more intensively, and that borrowers who have a long-term relationship with their main bank are more likely to pledge collateral. These findings suggest that collateral is complement

14、ary to relationship lending. In contrast, the complementarity between relationship lending and personal guarantees is weaker. As far as we know, this is the first empirical study that systematically examines the role of collateral and personal guarantees in Japans SME loan market. The two main contr

15、ibutions of the paper are as follows. First, given that Japan is generally considered to have a relationship-based financial system in which the relationship-lender, the main bank, plays a central role in corporate financing （Rajan and Zingales, 2003）, the study helps to improve our understanding of

16、 the role of collateral in relationship lending and complements existing studies that focus on the United States and Europe. Second, and more importantly, by distinguishing collateral and personal guarantees, the study detects an important role of collateral in relationship lending that has not been

17、 remarked on much before. As we argue below, although a typical SME in Japan has a long-term relationship with its main bank, it actually engages in transactions with several banks, which is not common in other countries. A possible corollary of this is that because of the informational 2 free-rider

18、 problem it creates, this practice may reduce the main banks incentive to screen and monitor borrowers. Since collateral defines the order of seniority among creditors, using collateral may mitigate the free-rider problem and enhance the main banks screening and monitoring. This incentive effect for

19、 the main bank becomes tenuous for personal guarantees, because personal guarantees do not define the seniority among creditors. Thus, our work provides empirical evidence on how collateral affects relationship lenders incentives, and complements previous studies that focus on the problem of borrowe

20、r incentives （moral hazard and adverse selection）. The remainder of the paper is organized as follows. Section 2 develops our empirical hypotheses which are based on previous theoretical models and empirical research. Section 3 describes the data and variables that are used in the paper, and explain

21、s our empirical model. Section 4 presents the results of our empirical analysis, and Section 5 concludes. 2 Empirical hypotheses 2.1 Borrower riskiness Much of the empirical literature in this field examines theoretical predictions of asymmetric information models on the relationship between risk an

22、d collateral. If the bank cannot discern borrowers riskiness （hidden information）, then collateral may serve as a screening device to distinguish between borrowers and to mitigate the adverse selection problem （Bester, 1985）. This follows from the observation that a lower-risk borrower has a greater

23、 incentive to pledge collateral than a risky borrower, because of his lower probability of failure and loss of collateral. Hence, the lower-risk borrower will choose the contract with collateral. On the other hand, if the lender can observe the ex-ante risk, but there are information asymmetries wit

24、h regard to actions taken by the borrower after the loan is extended, collateral potentially provides an incentive to mitigate moral hazard. Thus, opposite to models focusing on hidden information, those concentrating on hidden action suggest that it is observably riskier borrowers that will pledge

25、collateral, because collateral induces more effort by the borrower （Boot, Thakor, and Udell, 1991）, or reduces the incentives of strategic default （Bester, 1994）. Because our data base only contains measures of firms observed riskiness 3 （namely, credit scores）, we couch our first empirical hypothes

26、is as follows: Hypothesis 1 （H1）: The use of collateral is higher among observably higher-risk （low credit score） borrowers if the lender requires collateral in order to mitigate the extent of moral hazard. Alternatively, if borrowers pledge collateral as a signal of their unobserved high credit qua

27、lity, then there is negative or no relationship between the use of collateral and the credit score. Consistent with the theory of moral hazard, most existing empirical studies, including Berger and Udell （1990; 1995）, have found a positive relationship between collateral and borrowers ex-ante risk.

28、Jimnez, Salas and Saurina （2006） directly test the adverse selection and moral hazard hypotheses by separating ex-ante and ex-post measures of borrower riskiness, namely defaults prior to and after the loan origination. Their results suggest that although observed riskiness increases the likelihood

29、that collateral is used, there is also a negative association between collateral and default after the loan has been granted, which is consistent with the adverse selection argument. It should be noted that theories of collateral as a solution to moral hazard and/or adverse selection problems assume

30、 collateral is external to the firm. Unfortunately, our measure of the incidence of collateral does not distinguish between firm （inside） collateral and personal （outside） collateral. Hence, throughout our analysis, we will assume that collateral is mostly inside, but allow for the fact that there m

31、ay also be some outside collateral. As for personal guarantees, they clearly represent outside collateral. 2.2 Screening and monitoring by the lender Recent research on collateral also discusses how collateral affects lenders incentives with regard to information production, that is, the screening o

32、f borrowers quality and the monitoring of their performance. These theories of the effect of collateral on lenders incentives apply to both inside and outside collateral. Manove, Padilla, and Pagano （2001）, for instance, argue that, from banks point of view, collateral can be considered as a substitute for the evaluation of the actual risk of a borrower. Thus, banks that are highly protected by collateral may perform less screening of the projects they finance than is socially optimal.