A Dynamic Growth Model with Equity for Guarantee Swap and Asymmetric Information*

• Published date: 01 March 2021
• Author: Qi Liu,Dandan Song,Xiaolin Tang
• Date: 01 March 2021
• DOI: http://doi.org/10.1111/irfi.12253

A Dynamic Growth Model with

Equity for Guarantee Swap and

Asymmetric Information*

QILIU,DANDAN SONG AND XIAOLIN TANG

School of Finance and Statistics, Hunan University, Changsha, China

ABSTRACT

We develop an endogenous dynamic growth model in which a financially

constrained firm optimizes the entrance timing and financing structure in

different information exposure scenes. An innovation financing tool called

equity-for-guarantee swap is introduced to solve the dilemma of financing

constraints. The productivity of the firm is a random variable following a

two-point distribution and its value can be observed in advance by the entre-

preneur but not by the insurer. Our main goal is to fix the fair guarantee cost

with asymmetry information and examine how the cost differs from the one

under the same situation except with symmetric information. We solve a

Nash equilibrium of the game between the entrepreneur and the insurer and

specify the condition to determine whether a separating equilibrium or pool-

ing one will be achieved. We find that at the separating equilibrium, the

high-profitfirm will sacrifice a profit to send a signal for the purpose of sepa-

rating itself from the low-profit one by increasing the latter’s mimicking cost.

The pooling equilibrium occurs when the insurer can not distinguish the

firm’s type and therefore, the insurer demands the same guarantee cost for

all firms.

JEL Codes: G13; G32

Accepted: 31 December 2018

I. INTRODUCTION

Small- and medium-sized enterprises (SMEs) play a vital role in promoting eco-

nomic growth, while they also suffer from severe financial constraints arising

from information asymmetry between the firms and banks (Stiglitz and Weiss

(1981)). In order to lessen the financing constraints faced by SMEs, credit guar-

antee schemes (CGSs) have been developed and right now have been proved as

* The research for this paper was supported by National Natural Science Foundation of China

(Project No. 71502054), and Hunan Provincial Natural Science Foundation of China

(No. 2016JJ3046)

© 2019 International Review of Finance Ltd. 2019

International Review of Finance, 21:1, 2021: pp. 37–57

DOI: 10.1111/irfi.12253

an effective and popular way.

1

Specially, a new financial tool, called equity-for-

guarantee swap (EGS), which occured in ShenZhen of China in August 2002,

could significantly mitigate the dilemma of financing constraints faced by

SMEs.

2

EGS is an agreement among a bank/lender, an insurer and SME/borrower

where the SME can get the loan at a given interest rate from a bank. Once the

SME defaults on the loan, the insurer must pay all the outstanding interest and

principal to the bank instead of SME. In return, the SME need to allocate a frac-

tion of firm’s equity to the insurer. Therefore, from the EGS, we can see that

the bank is risk-free. That is to say, the asymmetric information between the

bank and SMEs transfers into the insurer and SMEs.

In this paper, we incorporate this asymmetric information between insurers

and SMEs in a dynamic endogenous growth model where the loan is realized

by the EGS. In this novel framework, the quality of a firm is characterized by

the productivity endogenously which is a random variable following a two-

point distribution and its value can be observed in advance by the borrower but

not the insurer. Naturally, there arise several problems: how much the informa-

tion of productivity is conveyed and in which way? How does a constrained

firm choose the pair of entrance scale and coupon rate as a signal tool to resolve

informational issue? How does asymmetric information affect a firm’s entrance

value? These are important issues that need to be solved.

Existing literature often focus on the cash flow which is produced by a fix

investment opportunity. The rapid changing of the capital stock provides the

firm a chance to adjust its behavior. Thus, the endogenous growth model

which is introduced to depict the dynamics of the firm arouses much interest

among the researchers. In our model, the amount of investment is closely cor-

related with the capital stock which is a critical variable. For an entrepreneur, a

critical problem that needs to be considered is how to choose a proper initial

capital to set up its factory. Naturally, the entrance problem is tightly closed

with the financing structure and the guarantee behavior.

A. Our contributions

The contributions of this paper to the literature are summarized as follows. First,

we introduce a new debt-financing tool into the dynamic endogenous growth

model. The optimal capital structure is formed. We take into account the interac-

tion between the guarantee behavior and the firm’s features including the capital

1 According to the world bank statistics data, nearly 79% bank loans need be guaranteed. And

there are over 2250 schemes implemented in different forms in almost 100 countries

(Green 2003).

2 Up to now, the famous guarantee company in China called Shenzhen HTI who initially used

EGS as a financing tool has already helped nearly 230 companies to realize their financial

demand, including the famous companies like Hans Laser and O-Film Tech. For more details,

please see http://www.szhti.com.cn/About/Index1.html. Many provinces in China push rules

to encourage this innovation product.

© 2019 International Review of Finance Ltd. 201938

International Review of Finance