Abstract
We examine the effect of ex ante litigation risk on the price and non-price terms of loan contracts. Since expected litigation is endogenous, we focus on federal circuit court judge ideology to generate plausibly exogenous variation in the outcome of a class action lawsuit. We find that loans issued by firms headquartered in circuits with a higher likelihood of drawing a liberal panel of judges in a class action lawsuit have higher loan spreads, shorter maturity, and a larger number of and more restrictive covenants. To strengthen our claim that judge ideology affects loan contracting through its effect on the outcome of a class action lawsuit, we show that the influence of judge ideology on price and nonprice terms of loans is strongly influenced by factors that influence the probability of a class action lawsuit. Overall, our results bolster the case that litigation risk has a causal effect on debt contracting.
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