Secured debt and lender environmental liability

Banks may face environmental liability when they extend secured loans but this liability does not extend to public secured debt. This paper introduces the concept of lender environmental liability to the literature of theoretical finance by extending the work of Stulz and Johnson (1985) and Schwartz (1981, 1984) to distinguish among three possible cases for lender environmental liability. Using option payoff graphs we demonstrate that secured debt can be worth less to the lender than unsecured debt. We reinforce this conclusion by employing a formal debt valuation model based on an extension of Lai (1995).