Equilibrium Collateral Values, Credit-Rationing and Risk-Shifting

We explore the determinants of liquidation values of collateral, focusing on the potential buyers of assets. When a fi rm in financial distress needs to seize assets, its industry peers are likely to be experiencing problems themselves, leading to a lower resale price. We use this endogenous resale price to analyze its interaction with ex-ante credit rationing and risk-shifting in loan contracts. Our contribution reveals that collateral does not necessarily solve for the asset substitution problem, but may even fuel moral hazard and credit rationing in banking. Particularly, lenders may prefer borrowers short of assets. This somewhat surprising result goes even from bad to worse if previously public information becomes private