Securitization: A Low Cost Sweetener For Lemons

  • Author(s): Claire Hill
  • Date Posted: 1995
  • Law & Economics #: 95-14
  • Availability: Citation only


Securitization is a technique firms use to raise financing. In securitization transactions, a firm issues securities payable from collections on its receivables. Securitization, in its present form, was created in the early 1970s. Transaction volume has grown rapidly; by the end of 1994, more than $1.9 trillion in securitization securities were outstanding. Financing transactions, such as securitization, are the principal means by which firms create their capital structures. Modigliani and Miller showed that in a world without transaction or other costs, a firm's capital structure cannot add value. I show how securitization can add value by identifying the real-world costs it reduces. I describe two different uses of securitization. One is for firms with many alternative financing possibilities. Such firms often use securitization to exploit small, temporary price differences in different financial markets. The cost reduction is small, but real. The other is for firms with fewer financing possibilities. There, the cost reduction is larger. This is because securitization seems particularly effective in reducing information costs. Information about firms with fewer financing possibilities is often limited, unfavorable or particularly difficult to appraise. Investor fears about such firms are costly to dispel. However, securitization reduces these costs by dividing the firm into slices which permit more specialized appraisal.