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Captive Finance Company Definition
A Captive Finance Company is a wholly-owned subsidiary whose function is to finance consumer purchases or finance retail items sold by the parent company. In other words, a captive finance company helps the customers of the parent company finance big purchases. Generally, captive finance companies are specialized companies that are into credit card services, lending services, and other banking services. Captive companies offer to finance to customers of whichever parent company owns them. For instance, a captive finance company owned by a cosmetic company can make loans for customers who need to purchase cosmetic products or require expensive services.
A Little More on Captive Finance Companies
A captive finance company is a wholly-owned subsidiary that is controlled by the parent company. These types of subsidiaries are established to extend financing to customers of the parent company for big purchases. For instance, parent companies such as Ford, Sears, and General Electric have wholly-owned subsidiaries that they established to extend loans to customers to enable them to make purchases. A captive finance company offers financial services solely to the customers of the parent company. Captive finance companies are commonly established in the automobile industry, for instance, Ford has Ford Motor Credit as its captive finance company, Toyota has Toyota Financial Services and many other automobile companies. These finance companies were created to offer to finance to customers who want to purchase an automobile.
Benefits of Captive Finance
It is important to know that captive finance companies are different from conventional banks and lending institutions. In most cases, these companies do not offer cash loans, rather they offer financing channeled to the purchase of goods and services directly from the parent company. The major benefits of captive finance companies are as follows;
- Captive finance companies offer better loan deals with lower interest rates to customers of a parent company.
- They are accessible to customers and have simplified loan process compared to conventional banks and lending institutions.
- They offer subsidized financial deals with lower risks.
- Captive finance companies also extend financing to customers or corporations with a poor credit rating that might otherwise be turned down by other financial institutions.
- They provide financial solutions to customers, helping them afford the payment for goods and services.
- These companies generate revenue for a parent company and its subsidiaries, they provide alternative means of income.
- Captive finance companies create a synergy between a parent company and other financiers.
References for Captive Finance Company
Academic Research on Captive Finance Company
Competition, credit policies, and the captive finance company, Banner, P. H. (1958). Competition, credit policies, and the captive finance company. The Quarterly Journal of Economics, 72(2), 241-258.
Vendor financing, Brennan, M. J., MAKSIMOVICs, V. O. J. I. S. L. A. V., & Zechner, J. (1988). Vendor financing. The Journal of Finance, 43(5), 1127-1141. This paper shows that, even in the presence of a perfectly competitive banking industry, it is optimal for firms with market power to engage in vendor financing if credit customers have lower reservation prices than cash customers or if adverse selection makes it infeasible to write credit contracts that separate customers according to their credit risk. We analyze how the advantage of vendor financing depends on the relative size of the cash and credit markets, the heterogeneity of credit customers, and the number of firms in the industry.
Emergence of captive finance companies and risk segmentation in loan markets: theory and evidence, Barron, J. M., CHONG, B. U., & Staten, M. E. (2008). Emergence of captive finance companies and risk segmentation in loan markets: theory and evidence. Journal of Money, Credit and Banking, 40(1), 173-192. 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.
Captive finance subsidiaries and the M-form hypothesis, Roberts, G. S., & Viscione, J. A. (1981). Captive finance subsidiaries and the M-form hypothesis. The Bell Journal of Economics, 285-295. Williamson’s theory of hierarchy is used to show that the widespread and, before now, unexplained corporate practice of establishing captive finance subsidiaries may be understood as an instance of multidivisional-form reorganization. It is argued that such reorganization enhances internal efficiency and eases the monitoring task of lenders, thus facilitating borrowing. The debt ratios of firms in five U.S. industries are examined and the evidence, while not conclusive, provides support for the hypothesis. Thinking of captive finance subsidiaries in terms of the theory of hierarchy is consistent with the rationale for finance subsidiaries presented by corporate officers.
A Re‐Examination of the Wealth Expropriation Hypothesis: The Case of Captive Finance Subsidiaries, Malitz, I. B. (1989). A Re‐Examination of the Wealth Expropriation Hypothesis: The Case of Captive Finance Subsidiaries. The Journal of Finance, 44(4), 1039-1047. This paper re‐examines Kim, McConnell, and Greenwood’s (1977) study of captive finance subsidiaries. We suggest that, as long as firms are concerned with reputation, shareholders will find it costly to engage in deliberate wealth expropriation and thus have no incentives to do so. Using a sample of fourteen firms with publicly traded debt, we compute and test the statistical significance of abnormal returns to shareholders, bondholders, and the firm when captives are incorporated. We find that shareholders gain 14.9 percent, bondholders lose 2.3 percent, and firm value increases a significant 10.4 percent. Our results are inconsistent with wealth expropriation and lend support to the importance of reputation to firms.
Captive Finance Subsidiaries: The Manager’s View, Roberts, G. S., & Viscione, J. A. (1981). Captive Finance Subsidiaries: The Manager’s View. Financial Management, 36-42.
Restructuring agribusiness for the 21st century, Boehlje, M., Akridge, J., & Downey, D. (1995). Restructuring agribusiness for the 21st century. Agribusiness, 11(6), 493-500. Significant changes are occurring in the agribusiness sector; these changes will dramatically impact the management of agribusiness firms from sourcing of inputs through operations, finance, sales and marketing, to final customer contact. Awareness of these changes is critical for strategic positioning and planning. We discuss 10 changes that we feel will have profound implications for the future structure and performance of the agribusiness industries.
Does corporate lending by banks and finance companies differ? Evidence on specialization in private debt contracting, Carey, M., Post, M., & Sharpe, S. A. (1998). Does corporate lending by banks and finance companies differ? Evidence on specialization in private debt contracting. The Journal of Finance, 53(3), 845-878. This paper establishes empirically the existence of specialization in private‐market corporate lending, adding a new dimension to the public versus private debt distinctions now common in the literature. Comparing corporate loans made by banks and by finance companies, we find that the two types of intermediaries are equally likely to finance information‐problematic firms. However, finance companies tend to serve observably riskier borrowers, particularly more leveraged borrowers. Evidence supports both regulatory and reputation‐based explanations for this specialization. In passing, we shed light on various theories of debt contracting and intermediation and present facts about finance companies.
‘Financial Distortion’and Consolidation of Captive Finance Subsidiaries In the General Merchandising Industry, Copeland, R. M., & McKinnon, S. (1987). ‘Financial Distortion’and Consolidation of Captive Finance Subsidiaries In the General Merchandising Industry. Journal of Business Finance & Accounting, 14(1), 77-97.
Capital structure rearrangements and me‐first rules in an efficient capital market, Kim, E. H., McConnell, J. J., & Greenwood, P. R. (1977). Capital structure rearrangements and me‐first rules in an efficient capital market. The Journal of Finance, 32(3), 789-810.
Captive financing arrangements and information asymmetry: the case of REITs, Wei, P., Hsieh, C. H., & Sirmans, C. F. (1995). Captive financing arrangements and information asymmetry: the case of REITs. Real Estate Economics, 23(3), 385-394. For the sample period of 1985 and 1986, captive real estate investments trusts (REITs) have a larger bid‐ask spread than noncaptive REITs, after controlling for trading volume, price volatility, insider holdings, institutional holdings and firm size. Based on the bid‐ask spread literature, the results suggest that captive firms are subject to a greater degree of information asymmetry. This implies a higher cost of capital for captive firms. The evidence here and the trend toward self‐administered REITs imply that information asymmetry and conflicts of interests within REITs are priced.
Captive Finance Companies: Their Growth and Some Speculations on Their Significance, Andrews, V. L. (1961). Captive Finance Companies: Their Growth and Some Speculations on Their Significance. Industrial Management Review (pre-1986), 3(1), 27.