Bank Loan Contracting Research Articles

Corporate noncompliance: Do corporate violations affect bank loan contracting?

We examine the effect of corporate violations on bank loan contracting and document that borrowers with higher corporate violation penalties have higher loan costs. Higher corporate violations are also associated with more restrictive covenants and a higher likelihood of a collateral requirement. The increasing effect of corporate violations on loan costs is concentrated in opaque firms or those subject to more competitive markets or ineffective monitoring. Firms with higher violation penalties have lower future performance and a higher number of future violations. Overall, our results demonstrate that banks factor corporate violations into their lending decisions, thus shedding new light on the economic consequences of corporate violations through the creditors’ lens.

Do Better Managers Get Better Loan Contracts?

This paper examines the impact of managerial ability on bank loan contracting. We find that firms with higher‐ability managers obtain more favourable loan contract terms, including lower loan spreads, fewer covenants, and more short‐term maturities. Furthermore, the negative relation between managerial ability and loan spread is concentrated in firms with higher information asymmetry, higher default risk, or lower agency costs of debt. Finally, we find that firms with higher‐ability managers are more likely to choose public bonds over bank loans.

How does currency risk impact firms? New evidence from bank loan contracts

We use unique features of the private credit market to examine if and how currency risk impacts firms' financing and whether currency risk is a priced systematic risk at the firm level. We find that currency exposure has a large impact on loan spreads. Decomposing loan spreads, we find that exposure increases the expected default loss premium and that internationalization, growth opportunities, and relationship intensify exposure's impact. Further, exposure exacerbates firms' financing risk by increasing the need for collateral, reducing loan maturity, inducing monitoring and covenant intensity, and influencing syndicate structure. However, exposure does not affect the expected return premium in loan spreads; hence, currency risk does not appear priced in the classical sense and, therefore, should not affect the “true” cost of debt. Our findings imply that while managers should be concerned about exposure's impact on their access to, and terms of, bank financing, they should not adjust hurdle rates on account of exposure when assessing investment projects.

How do big customers influence bank loans in China? The role of state ownership and political connections

AbstractFirms with big customers are associated with not only high operational efficiency but also high operational risks. We study the effect of big customers on various aspects of bank loan contracts using a manually collected contract‐level dataset from China over the period of 2001–2016. We find that, big customers help firms obtain lower borrowing interest rates, longer loan duration, and larger loan amounts, though this is accompanied by more restrictive borrowing conditions. We further find that state ownership and political connections are important considerations when banks make loan decisions to firms with big customers. Overall, our results show how benefits and costs of big customers are evaluated by banks and priced into bank loan contract terms.

Effects of time-varying political connections on loan contracts

PurposeThe authors construct two time-varying political connection (PC) indexes to measure a firm's political tendencies toward ruling and opposing parties and analyze whether a firm with ruling party tendencies obtains better bank loan contracts compared to the contracts obtained by a firm with opposing party tendencies and a firm with fixed PC tendencies.Design/methodology/approachLinguistic text mining is used to construct the two time-varying PC indexes from news sources that reflect the tone and frequencies of characteristic texts to determine a firm's tendencies to favor the ruling or opposing parties.FindingsThe results show that varying PC firms connected to the ruling party receive preferential loan contracts when their political tendencies increase but varying PC firms connected to the opposition party do not. In contrast, fixed PC firms gain similar benefits only when the connection is determined in the presidential election year but not in other years. Firms supporting two parties receive minimal financial rewards in terms of loan terms.Originality/valueIn past studies, once a firm is identified as having a connection with a political party, it is assumed to have PC throughout the sample period (i.e. fixed PC firms). The authors lift this assumption and examine how varying PC affect bank loan contracts. The two time-varying PC indexes can identify a firm's more immediate party tendencies and more precise effects of a firm's party tendencies on bank loan contracts.

Statute of Limitations for Restitution Claims after a Term is Declared Unfair. Some Remarks on the CJEU Judgment of 8th of September 2022 (Joined Cases C-80/21 to C-82/21)

Abstract The article refers to the problem of Statute of limitations for restitution claims after a term is declared unfair in light of the ECJ judgment of 8th of September 2022 (Joined Cases C-80/21 to C-82/21). In light of the ECJ judgment one may not argue that if there was a sanction that would deprive a consumer effective claim for restitution because of excessive effect of statute of limitation, such mechanism would be contrary to the aim of protection under Directive 93/13. The regulation contained in Directive 93/13 should not allow for 10‑year limitation period for a consumer’s action for the restitution of the payments made under 30-years lasting bank loan contract if the limitation period passed before the consumers claim has been payable. The ECJ judgment might be perceived as somewhat superfluous, because such an effect would also be difficult to accept that in the light of the principles of the civil law – certainly Polish law, which should give a ground for the assumption provided in the question submitted by the referring court. However, the ECJ ruling itself does not seem to be controversial.

Climate Reputation and Bank Loan Contracting

Climate Reputation and Bank Loan Contracting

The Impact of FASB Staff Position APB 14-1 on Corporate Financing: A Debt Contracting Perspective

Using a set of hand-collected data, we study the economic consequences of FASB Staff Position APB 14-1, which was adopted in 2008 and intended to increase reported interest expense and decrease reported leverage. First, we document that issuers are more likely to respond to APB 14-1 by reducing the outstanding amount of cash-settled convertible debt when they are more able to bear the cost of repurchase. Second, we explore the debt contracting explanations for issuers’ repurchase decisions. In particular, we focus on the contracting practice for GAAP changes and the inclusion of financial covenants related to interest coverage ratios. We find that issuers are less likely to repurchase the outstanding cash-settled convertibles when their bank loan contracts allow them to request a freeze on GAAP provisions to exclude mandatory GAAP changes in calculating accounting-based covenants. Further, when firms’ bank loan contracts contain financial covenants related to interest coverage ratios, issuers are more likely to repurchase outstanding cash-settled convertibles to avoid technical default due to the higher reported interest expense resulting from requirements under APB 14-1. These empirical results are consistent with the notion that firms do respond to mandatory GAAP changes when they are more able to afford the cost of such responses. Furthermore, debt contracting practices can help explain firms’ decisions to respond to mandatory GAAP changes.

Cost stickiness and bank loan contracting

This study examines whether and, if so, how borrowers' asymmetric cost behavior (i.e., cost stickiness) is factored into the price and non-price terms of bank loan contracts. We provide strong and reliable evidence that ex-ante, the loan spread increases with cost stickiness after controlling for other known determinants of loan contract terms. Moreover, we find that the effect is more pronounced for borrowers with higher default risk and higher information risk. This is consistent with borrowers' asymmetric cost behavior increasing lenders' uncertainty about the liquidation value of assets, and hence, lenders need to be compensated ex-ante. Additionally, we conjecture that higher cost stickiness may increase the need for ex-post monitoring. Consistent with this conjecture, we find some evidence that lenders impose tighter non-price terms on firms with stickier costs. This study integrates cost stickiness research with the banking literature by showing that banks incorporate borrowers' asymmetric cost behavior into loan contracting terms.

Borrower Technology Similarity and Bank Loan Contracting

Borrower Technology Similarity and Bank Loan Contracting

CFOs’ facial trustworthiness and bank loan contracts

Using a well-developed machine learning-based image processing algorithm, we investigate whether a bank considers the facial trustworthiness of the chief financial officer (CFO) of a borrower firm for loan contracts. Based on a large sample of public firms in the United States, our results show that banks tend to offer lower loan spreads and are less likely to use collateral for firms with more facially trustworthy CFOs. Further, the results hold when we control the chief executive officers' (CEOs') facial trustworthiness, implying that it is the CFOs who negotiate with the banks about loan contracts. The effect of CFOs' facial trustworthiness on bank loan contracts is more pronounced in small or young firms, and less pronounced for firms in financial distress. Our study adds to the literature on the determinants of bank loan costs and the influence of managers’ facial features on corporate finance and corporate governance.

CEO compensation and bank loan contracts

This paper studies the relationship between bank CEO inside debt holdings and banks’ syndicated loan decisions. Using a two-stage selection model, we find that banks with higher CEO inside debt holdings extend syndicated loans to safer borrowers and have a smaller number of lenders in the syndication; these loans have a lower spread, less restrictive covenant, and longer maturity. These results suggest higher bank screening efforts and lower risk-taking incentives associated with bank CEO inside debt. The findings are robust to potential endogeneity bias and simultaneity of various loan terms.

Are banking and accounting expertise on the audit committee related to bank loan terms?

AbstractThe extant literature reveals that audit committee (AC) members with industry expertise can enhance the AC's effectiveness in monitoring the financial reporting process. In this study, we focus on AC banking and accounting expertise and examine their effects on bank loan contracting, respectively. We find that banks offer more favorable price term (i.e., interest rate) and non‐price terms (i.e., lower likelihood of providing collateral, more financial covenants, and longer maturity) to borrowers whose AC members have banking or accounting expertise. Second, we find that the association between AC expertise and loan terms is driven more by banking expertise, either alone or in conjunction with accounting expertise, than by accounting expertise alone. The results are robust to a battery of robustness tests. Overall, our results suggest that banks value borrowers’ AC banking experts as well as accounting expertise when designing loan terms.

Corporate environmental responsibility and bank loans

AbstractDrawing on both qualitative analyses of banks' sustainability reports and quantitative analyses of 11,538 bank loans from 1993 to 2018, we explore interactions between corporate environmental responsibility (CER) and bank loan contracting. We find CER dominates how corporate social responsibility (CSR) affects bank loans. We propose a two‐way relationship between CER and bank loans. Firms with strong CER performance receive cheaper bank loans due to banks' environmental risk management efforts. These banks provide services to corporate borrowers that have a positive influence on borrowers' ongoing environmental performance.

Blockholder board representation and debt contracting

We examine the impact of blockholder board representation on a borrower's bank loan contract terms and find it is associated with lower spreads and fewer negative covenants. When examining the potential channels behind the relationship, we find that blockholder-directors who take dedicated monitoring roles, as opposed to the short-term or confrontational positions often associated with activist shareholders, drive the overall relationship. The findings, which are robust to alternative model specifications and explanations, suggest that blockholder-directors can serve as substitute monitors to debtholders when their incentives are aligned. The results also highlight the heterogeneity among blockholders who actively influence the management process.

CEO Duality and Bank Loan Contracting: Evidence from China

ABSTRACT This paper investigates the impact of CEO duality on bank loan contracting costs. Using hand-collected data of China’s loan contracting terms throughout 2004–2020, we find that CEO duality leads to stricter loan contracting terms, shown as higher adjusted loan rates and shorter loan maturity. The results hold after we perform robustness tests including change analyses, propensity score matching analyses, as well as tests based on exogenous CEO turnovers. The positive relationship between duality and loan costs is more pronounced among firms with higher internal and external uncertainties. We further find that information asymmetry and CEO entrenchment are possible channels through which CEO duality increases bank loan contracting costs. Overall, the evidence supports the agency theory view that CEO duality increases firm’s credit risk, thus leading to stricter bank loan contracting terms.

Lender Trust and Bank Loan Contracts

We examine the contractual implications of a lender’s trust for corporate loans. We measure how trusting a lender is using the average trust attitude in the chief executive officer’s ancestral country of origin. We find that banks with trusting CEOs charge lower interest rates in U.S. syndicated loans. This effect is identified within existing lender–borrower relationships and similar types of loans. Further analyses indicate that trust reduces the cost of credit by boosting the perceived credibility of borrower information and by mitigating contracting problems. We corroborate our findings by conducting a survey of loan officers with experience in loan syndication. This paper was accepted by Gustavo Manso, finance. Supplemental Material: The internet appendix and data are available at https://doi.org/10.1287/mnsc.2022.4371 .

REVISITING INFLATION-GROWTH NEXUS: AN ENDOGENOUS GROWTH MODEL WITH FINANCIAL FRICTIONS

This paper presents a new explanation of why the growth effect of inflation reported in the literature is an inverted-U relationship with considerations of lower bound on bank lending rates. We integrate a non-zero lower bound on the lending rate in the discussion and show the effect of inflation on optimal bank loan contracts. This paper believes that informational friction is a source of the negative relationship between inflation and growth when the loan rate constraint is non-binding. Besides, it finds out that once this loan rate constraint is binding, increasing inflation can reduce the real cost of financing capital investment and then contribute to growth. This paper also proves that the non-zero lower limit can only be reached at the low rate of inflation. It implies developing countries that are more likely to have low capital conversion efficiency and high transaction cost would hold a higher inflation-growth nexus than developed countries.

Customer concentration and bank loan contracting: evidence from China

ABSTRACT This study uses hand-collected data regarding bank loan terms for Chinese listed firms to investigate whether and how a concentrated customer base affects bank loan contracting. We find that a more concentrated customer base reduces suppliers’ credit risk, which results in more favorable bank loan contracting terms (i.e. lower interest rates, longer maturities, and larger loan sizes). Furthermore, we provide evidence that increased operational efficiency, reduced information risk and default risk are possible channels through which customer concentration reduces bank loan contracting costs. The results are robust to a set of additional tests. Overall, our findings document the benefits of customer concentration in developing countries such as China and reveal how this benefit is priced into bank loan contract terms.

PCAOB international inspection access and debt contracting: Evidence from American Depositary Receipt firms

We examine whether the Public Company Accounting Oversight Board’s (PCAOB’s) international inspection access affects the usage of accounting-based debt covenants in bank loan contracts of American Depositary Receipt (ADR) borrowers. We show that there is an increase in the use of financial covenants in debt contracts after the auditor of an ADR borrower becomes subject to PCAOB inspections. We also document that lenders increase the usage of financial covenants only in loans to ADR borrowers domiciled in countries with weak home country intuitions, and the increase is more pronounced for ADR borrowers from countries without a local auditor regulatory oversight body. These findings suggest that PCAOB regulatory oversight enhances the perceived credibility of accounting numbers for debt contracting and serves as a substitute for the weak monitoring of auditors for ADR borrowers domiciled in countries with weak country institutions.