Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

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468 Answers to Chapter Discussion Questions

irrelevant, or some of its assets. When borrowers pledge receivables as security,

the debt is nonrecourse.

2. While there is not a perfectly tight empirical link between secured debt and bank

debt, the two are highly correlated. Public debt is rarely secured, but bank and

finance company debt is usually secured. The strongest theoretical tie between

secured debt and bank debt is in the area of monitoring and efficient liquida-

tion. Levmore (1982) and Triantis (1992) suggest that secured debt improves

coordination and efficiency in monitoring. Given the central role of monitoring

in explaining the use of bank debt, using secured debt to promote monitoring

is consistent with the frequent coexistence of bank lenders and security provi-

sions. Analysis of liquidation incentives more strongly supports a link between

bank debt and secured debt. Models by Repullo and Suarez (1998) and Gorton

and Kahn (2000) show that bank debt should be senior and secured because the

ability of a bank to act unilaterally, combined with the liquidation incentives of

seniority, lead to efficient liquidation choices. The pattern of bank and finance

company loans in Carey, Post, and Sharpe (1998) is generally consistent with the

efficient liquidation argument.

3. The evidence supporting the use of secured debt to signal borrower quality

is mixed. Leeth and Scott (1989) find evidence consistent