Complements or substitutes: the relation between personal commitment and property based collateral pledging. (27th August 2010) - Rottke, Nico
Some studies indicate that there is only little difference between business and personal risks among small businesses. Personal assets and wealth can become subject to business risks depending on the organisational and legal structure chosen for the business. By the choice of the organisational and legal form the owner has a chance to increase the separation between the two classes of risks. However, lender's requirements for personal commitments, e.g., guarantees, mitigate the benefits of limited liability provisions. While recent studies concentrate on the lending relationships of small business borrowers we provide additional evidence for German medium-sized companies, the so-called German Mittelstand. There are two main findings: first, (property based, mortgage backed) internal collateral appears to be complement for outside personal commitments. Poorly performing companies have to provide more inside collateral and pledge guarantees with a higher probability than good borrowers do. Secondly, medium-sized corporations in Germany are less likely to provide guarantees than unincorporated firms. We interpret this finding as evidence that the owners of medium-sized companies have the market power to separate between business and personal risks. However, the pledging of property based collateral remains the most important risk reducing instrument from a lender's perspective.