PUBLICATIONS & REPORTS

Contents Introduction

In this study, we develop a set of models to analyze corporate loan guarantee to better understand the Korean government’s regulation policies. We find that corporate loan guarantees are efficiency-neutral under a set of ideal economic conditions characterized by perfect and symmetric information, no agency problems, and no governmental interference in private financial contracts. In reality, though, corporate loan guarantees have negative as well as positive effects on firms’ behavior. Negative effects arise from principal-agent problems as well as government interferences in private financial contracts. In the presence of information asymmetry, a positive effect of corporate loan guarantee may result by making good use of the fact that the guarantor firm has more information than the lending bank with regards to the borrowing firm’s investment project. Specifically, loan guarantee contracts can function as a signalling mechanism enhancing the efficiency in investment fund allocation.