Collateral, Risk Management, and the Distribution of Debt Capacity




    Search for more papers by this author
    • Adriano A. Rampini and S. Viswanathan are at Duke University. We thank Michael Fishman, Denis Gromb, Jeremy Stein, two referees, and the Acting Editor, as well as Amil Dasgupta, Douglas Diamond, Emmanuel Farhi, Alexander Gümbel, Yaron Leitner, Christine Parlour, Guillaume Plantin, David Scharfstein, David Skeie, René Stulz, and seminar participants at the Federal Reserve Bank of New York, Southern Methodist, Duke, Michigan State, INSEAD, Vienna, Stockholm School of Economics, Mannheim, Illinois, Zürich, British Columbia, Toronto, Minnesota, ETH Zürich, Ohio State, Columbia, Maryland, Washington University in St. Louis/the Federal Reserve Bank of St. Louis, Collegio Carlo Alberto, the European University Institute, the Jackson Hole Finance Group, the University of Chicago GSB conference “Beyond Liquidity: Modeling Frictions in Finance and Macroeconomics,” the 2008 Basel Committee/CEPR/JFI conference, the Paul Woolley Centre conference at LSE, the 2008 North American Summer Meeting of the Econometric Society, the 2008 SED Meeting, the 2008 NBER Summer Institute in Capital Markets and the Economy, the 2008 Minnesota Workshop in Macroeconomic Theory, the 2008 Washington University Conference on Corporate Finance, the 2008 Conference of Swiss Economists Abroad, the 2009 AEA Meeting, the European Winter Finance Conference, and the 2009 FIRS Conference for helpful comments and Wei Wei for research assistance. This paper was previously circulated under the title “Collateral, Financial Intermediation, and the Distribution of Debt Capacity.”


Collateral constraints imply that financing and risk management are fundamentally linked. The opportunity cost of engaging in risk management and conserving debt capacity to hedge future financing needs is forgone current investment, and is higher for more productive and less well-capitalized firms. More constrained firms engage in less risk management and may exhaust their debt capacity and abstain from risk management, consistent with empirical evidence and in contrast to received theory. When cash flows are low, such firms may be unable to seize investment opportunities and be forced to downsize. Consequently, capital may be less productively deployed in downturns.