The ability to pledge collateral enhances a firm's debt capacity, and providing outside investors with the option to liquidate pledged assets acts as a strong disciplining device on borrowers. Therefore, asset liquidation values play a key role in determining a firm's debt capacity. When these asset values decline during business downturns, it can depress investment and potentially amplify the downturn. Indeed, this "collateral channel" often is invoked when discussing the severity of the Great Depression or the extraordinary expansion of the Japanese economy at the end of the 1980s.
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