Emergence of Captive Finance Companies and Risk Segmentation in Loan Markets: Theory and Evidence

John M. Barron, Byung Uk Chong, Michael E. Staten

Research output: Contribution to journalArticle

6 Scopus citations

Abstract

A seller with some degree of market power in its product market can earn rents. In this context, there is a gain to granting credit to purchase of the product and thus to the establishment of a captive finance company. This paper examines the optimal behavior of such a durable good seller and its captive finance company. The model predicts a critical difference between the captive finance company's credit standard and that of independent lenders ("banks"), namely, that the captive finance company will adopt a more lenient credit standard. Thus, we should expect the likelihood of repayment of a captive loan to be lower than that of a bank loan, other things equal. This prediction is tested using a unique data set drawn from a major credit bureau in the United States, and the evidence supports the theoretical prediction.

Original languageEnglish (US)
Pages (from-to)173-192
Number of pages20
JournalJournal of Money, Credit and Banking
Volume40
Issue number1
DOIs
StatePublished - Feb 1 2008
Externally publishedYes

Keywords

  • Captive finance company
  • Consumer loan market
  • Differential loan performance
  • Monopolistic competition

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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