Reputation and Loan Contract Terms: The Role of Principal Customers

Abstract

Principal customers have strong incentives to screen and/or monitor suppliers to ensure supply-chain stability; consequently, the implicit certification from the existence of long-term relationships with principal customers has reputational consequences that potentially spill over to other markets. We argue that one such consequence is smaller loan spreads and looser loan covenants on bank loans, as firms that are able to hold on to principal customers longer are perceived as safer firms by banks. We address causality and endogeneity issues via a variety of tests and find consistent results. Our study suggests that non-financial stakeholders can have important effects on the decisions of financial stakeholders.