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

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 ca...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 2008-02, Vol.40 (1), p.173-192
Main Authors: BARRON, JOHN M., CHONG, BYUNG-UK, STATEN, MICHAEL E.
Format: Article
Language:English
Subjects:
Analysis
Automobile loans
Bank credit
Bank loans
Banks (Finance)
Captive finance
captive finance company
Company business management
consumer loan market
Consumer loans
Credit market
Credit markets
D81
D83
differential loan performance
Durable goods
Economic aspects
Finance companies
Financial economics
Financial institutions
Financial risks
Financial services
G21
Loan defaults
Loan rates
Loans
Management
Market segmentation
Monopolistic competition
Personal loans
Retail banking
Statistics
Studies
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Summary: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.
ISSN:0022-2879
1538-4616
DOI:10.1111/j.1538-4616.2008.00108.x