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The decline in secured debt

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Nitish Kumar

Assistant Professor of Finance Nitish Kumar

“What role does collateral play in corporate borrowing?” ask Assistant Professor of Finance Nitish Kumar and his colleagues Efraim Benmelech of Northwestern University and Raghuram Rajan of the University of Chicago. The researchers explain that collateral comforts and protects a lender against the threat of a default.

“When an effective system of seniority of claims is not available, creditors who register the collateral backing their debt with a collateral registry effectively establish the seniority of their debt claim, at least up to the value of that collateral,” the authors add.

Why then, as the authors find in the first part of their study, has there been a steady decline in secured debt issuance by U.S. corporations in the last century? The authors answer that question in the second part of their study by arguing that the benefits to creditors of securing collateral upfront had fallen over time. The authors then allude to the “dark side” of pledging collateral, and argue that the cost to firms of pledging collateral has increased over the last century.

Read all of what Kumar, Benmelech and Rajan found in this story from the Harvard Law School Forum on Corporate Governance.