Bank Loan Spread and Private Information: Pending Approval Patents

Abstract

This study examines a specific source of borrowers’ proprietary information and lenders’ ex ante information advantage, i.e., private information about the borrowers’ forthcoming patents. We examine this unique setting, where borrowers have credible information regarding a positive future event – the granting of a patent, to provide evidence of a specific source of and benefit from proprietary information. We find evidence consistent with lenders incorporating such proprietary information in the loan contract by charging borrowers with private information a lower spread than borrowers that lack that information. We also document a strong negative association between loan spread and the citation count on the newly granted patents, consistent with borrowers providing lenders with detailed information regarding the future expected cash flows from the forthcoming patents and lenders responding through a reduction in interest costs for those borrowers. Moreover, our cross-sectional tests show that the reduction in loan spreads is greater for borrowers with higher initial information uncertainty and default risk at loan initiation, and when the lead lender has greater loan concentration in the borrower’s industry. Finally, we document that the negative association between the patent information and loan spreads holds primarily among borrowers with shorter patent-to-cash cycles in longer-term loans (where there is a greater likelihood that the patent will generate positive cash flows during the loan term), consistent with lenders relying on patent-specific information in setting spreads. Our results suggest that patent pending approvals are a significant source of proprietary information useful to borrowers and employed by lenders in setting spreads.