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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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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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description	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.
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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. 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source	International Bibliography of the Social Sciences (IBSS); JSTOR Archival Journals and Primary Sources Collection; Wiley-Blackwell Read & Publish Collection; Business Source Ultimate (EBSCOHost)
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
title	Emergence of Captive Finance Companies and Risk Segmentation in Loan Markets: Theory and Evidence
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