Investment Distortion by Collateral Requirements: Evidence from Japanese SMEs

Author Name OGURA Yoshiaki (Waseda University)
Creation Date/NO. April 2015 15-E-050
Research Project Study on Corporate Finance and Firm Dynamics
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First draft: April 2015
Second draft: April 2017
Third draft: March 2018


We examine the significance of the distortionary effect of the collateral requirement on investments in assets pledgeable for collateral by small and medium-sized enterprises (SMEs). The theory predicts that the binding collateral constraint causes overinvestment if the price of pledgeable assets is expected to rise steeply while it causes underinvestment otherwise. Our structural estimation of the Euler equation under a collateral constraint using the dataset on Japanese SMEs in the 1980s and 1990s shows that the collateral constraint is binding when the price of a pledgeable asset is declining, whereas it is not when the price is increasing. This finding indicates that the binding collateral constraint primarily causes the problem of underinvestment for many SMEs in a recession and casts doubt on the welfare effect of the loan-to-value (LTV) ratio cap as a macroprudence policy because of the subsequent prolonged economic slump.