Adverse Selection versus Moral Hazard in Financial Contracting: Evidence from collateralized and non-collateralized loans

Author Name UCHIDA Hirofumi (Kobe University) / UESUGI Iichiro (Faculty Fellow, RIETI) / IWAKI Hiromichi (Japan Society for the Promotion of Sciences)
Creation Date/NO. March 2017 17-E-058
Research Project Study on Corporate Finance and Firm Dynamics
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We test the existence of adverse selection and moral hazard in financial contracting by examining the choice of borrowers between collateralized and non-collateralized loans. Using comprehensive loan-level data from all loans underwritten by a large public bank in Japan, we examine the borrowers' behavior before and after the introduction of non-collateralized loans that expand the choice set for borrowers. We find an increase in credit risk for firms that switch to non-collateralized loans after the introduction, which is consistent with moral hazard. In contrast, we find mixed and unclear evidence for the existence of adverse selection.