Systematic risk and secured debt

Abstract

Unsecured debt has gained little attention in the academic literature. The existing literature considers all debt as secured. However, firms use different types of debt in different situations. Thus, the different debt instruments are important for firms’ corporate policy decisions in the presence of financial constraints. In this paper, we investigate the relation between firms’ choice of debt and the investments undertaken. We will show that firms with lower costs of financing can invest more. Our research is based on data concerning capital structures of U.S. public manufacturing firms, gathered in the period of 1996-2012. Our results show that unsecured is cheaper than secured debt. Greater access to unsecured debt will therefore lead to more investments. When the access to unsecured debt is restricted, firms substitute toward secured debt and reduce their investments. Our results also show that lower spreads are not caused by the volatility of collateral, suggesting that collateral is not the key element to finance investments. We will therefore conclude that creditworthiness is more important than collateral, as creditworthiness gives access to the unsecured debt market. Key words: Debt structure, unsecured debt, investments, financial constraints, collateral, creditworthiness.