The Effect of Bond Market Transparency on Bank Loan Contracting

Abstract

We find that bond issuers receive bank loans with 12% fewer covenants when the secondary corporate bond market becomes more transparent. The treatment effect is more pronounced when bond trades are more informative, when stock prices are less informative, and when the likelihood of future debt-equity agency conflicts is higher. The evidence suggests that bond prices in a transparent secondary bond market reflect forward-looking information that mitigates banks’ information risk when entering into loan contracts. As such, banks impose fewer contractual restrictions in lending agreements. Treatment firms are also less likely to employ gradually tightening dynamic-threshold covenants as a signaling device. Finally, we find corroborating evidence from primary bond issues. Taken together, our findings suggest that secondary bond market frictions affect debt contract design.