Comment on Market Conditions and Contract Design: Variations in Debt Contracting

Abstract

This Comment attempts to explain two stylized facts: As the market interest rate rises, lenders demand either (a) more collateral, or (b) tighter covenants. In their Article, Market Conditions and Contract Design: Variations in Debt Contracting , Choi and Triantis (“C&T”) use two models in their explanation of these facts: an adverse selection model and a moral hazard model. The adverse selection model formally analyzes only collateral contracts, but the authors claim that both the collateral contract and the covenant contract mitigate adverse selection. The moral hazard model also considers only collateral contracts; the claim here is that these best mitigate moral hazard.