Lender Monitoring Research Articles

Under the Lender’s Looking Glass

This paper studies the impact of bank monitoring on the risk of US equity REITs. Using a unique, hand-collected data sample of mortgage balances, I show that bank screening and monitoring of REIT assets via utilizing secured mortgage financing (vs unsecured, public debt) lowers the overall company risk of a REIT. At the asset level, screening results in retail and office assets with higher acquisition values and located in primary markets, i.e., more transparent assets, being pledged as collateral. Further, I find evidence consistent with the role of lender monitoring for secured mortgage loans and show that properties located in closer proximity to a REIT’s headquarters are more likely to be pledged as collateral for a mortgage.

Active CDS Trading and Managerss Voluntary Disclosure

We investigate how the development of the credit default swap (CDS) market affects firms’ voluntary disclosure choices. The CDS market has been criticized, inter alia, for (i) its vulnerability to insider trading by informed lenders who trade on borrowers’ private information, and (ii) the reduction in lenders’ monitoring efficiency due to their ability to shed credit risk exposure via CDSs. Consistent with voluntary disclosure theory, we predict that informed trading by lenders and the consequent threat of private information revelation in the spreads of actively traded CDSs will pressure managers to enhance their voluntary disclosures to mitigate the risks associated with non-disclosure. Further, the reduction in lender monitoring will lead shareholders to intensify their own monitoring efforts and demand increased voluntary disclosures from managers. Consistent with these predictions, we find that managers are more likely to issue earnings forecasts and to forecast more frequently when their firms have actively traded CDSs. Our results also suggest that liquid CDSs discipline managers to disclose bad news earnings forecasts, despite their career- and wealth-related incentives to withhold adverse information. In addition to disclosure via management forecasts, we document that liquid CDSs also enhance disclosure via firm-initiated press releases. Our findings suggest that the allegedly negative attributes of the CDS market could result in a positive externality for capital markets by eliciting enhanced voluntary disclosures and thus contribute to a richer information environment.

Affiliated Banker on Board and Conservative Accounting

ABSTRACT We examine the effect of lender monitoring through board representation, which we label “affiliated banker on board” (AFB) on conservative accounting. We hypothesize that monitoring reduces lenders' demand for conservatism-facilitated control transfers through debt covenants by reducing the information asymmetry that underlies the agency problem of debt. Consistent with our hypothesis, we find that AFB firms have markedly lower conservative accounting than non-AFB firms. This result is robust to a battery of tests that account for bias from both observable and unobservable factors. We also find additional evidence to support key elements of our hypothesis. First, an examination of the relation between borrower-unfavorable renegotiations and covenant violations suggests that board representation allows lenders to renegotiate in a timelier manner based on private information. Second, an examination of the relation between covenant intensity and conservative accounting suggests that board representation decreases lenders' reliance on conservatism-facilitated control transfers. Finally, an analysis that uses relationship lending as an alternative proxy of lender monitoring suggests that it is lender monitoring, and not AFB per se, that reduces demand for conservative accounting. JEL Classifications: G3; G21; M41 Data Availability: All data are publicly available from sources identified in the text.

Private Sector Share of External Debt and Financial Stability: Evidence from Bank Loans.

Since the 1990s, the private sector in developing countries has contracted a substantially larger share of foreign-currency debts (external debts). In this paper, I empirically examine the effect of private sector external debts on bank loan prices. I find that, in general, the private sector share of external debts negatively and significantly impacts the price of bank loans, affecting public sector and private sector borrowers alike. This result demonstrates that private sector debts constitute a factor of international financial stability compared with public sector debts. Further analysis reveals that this impact is mitigated by the existence of a fixed foreign exchange regime showing that the private sector is still able to take advantage of potential market distortions and may subsequently become a factor of financial instability. Moreover, the private sector share of external debts has a positive impact on economic growth and lender monitoring. These additional results explain the gain in financial stability associated with the private sector.

Moral hazard and peer monitoring in a laboratory microfinance experiment

This paper reports the results from a laboratory microfinance experiment of group lending in the presence of moral hazard and (costly) peer monitoring. We compare peer monitoring treatments in which credit is provided to members of the group to individual lending treatments with lender monitoring. We find that if the cost of peer monitoring is lower than the cost of lender monitoring, peer monitoring results in higher loan frequencies, higher monitoring and higher repayment rates compared to lender monitoring. In the absence of monitoring cost differences, however, lending, monitoring and repayment behavior is mostly similar across group and individual lending schemes. Within group lending, contrary to theoretical predictions, simultaneous and sequential lending rules provide equivalent empirical performance.

Short-Term Debt Maturity Structures, Credit Ratings, and the Pricing of Audit Services

ABSTRACT: Short-term debt and credit ratings have benefits for financial reporting quality that may be associated with lower audit fees. Using U.S. data for 2003 through 2006, we find that short-term debt is negatively related to audit fees for firms rated by Standard & Poor’s, consistent with more monitoring and better governance mechanisms in firms with higher short-term debt. Credit ratings quality is negatively related to audit fees, consistent with ratings quality reflecting a firm’s liquidity risk, governance mechanisms, and monitoring from rating agencies. We also find that the negative relation between short-term debt and audit fees is stronger for firms with low-quality credit ratings, consistent with auditors pricing lender monitoring.

Stock Market Reaction to Sell-Offs Announcements: Canadian Evidence

This study examines the effects of Canadian divestitures announcements on selling companies’ shareholder wealth. Using a non parametric bootstrap approach to test for significance, our results show that the sell-off announcement produces significant positive average abnormal returns of 0.92% over a two day announcement period. Gains arise predominantly from divestitures that focus firm’s activities. A cross sectional regression shows that private lender monitoring and focused operations have a positive and significant wealth effect on the divesting firms.

Corporate Asset Sales in Taiwan

In this paper, we study a sample of 179 corporate asset sales in Taiwan between 1993 and 2003. We find that corporate asset sales in Taiwan enhance parent firm value with cumulative abnormal returns of 1.7715% for the pre-announcement five-day period and 0.6086% for the two-day announcement window. This finding is consistent with the evidence discovered in both UK and US. We also examine whether asset-sale gains are positively related to managerial performance, private lender monitoring, the use of proceeds, the type of asset sales, the profitability of asset sales, and the relative size of asset sales. Our cross-sectional regression results indicate that all variables, except private debt monitoring and relative size, appear with their predicted signs, but not all of them are statistically significant. During longer event windows, we find that only managerial performance measured by Tobin's q and the use of asset-sale proceeds can explain the gains from corporate asset sales in Taiwan.

Group-lending: Sequential financing, lender monitoring and joint liability

We develop a simple model of group-lending based on peer monitoring and moral hazard. We find that, in the absence of sequential financing or lender monitoring, group-lending schemes may involve under-monitoring with the borrowers investing in undesirable projects. Moreover, under certain parameter configurations, group-lending schemes involving either sequential financing, or a combination of lender monitoring and joint liability are feasible. In fact, group-lending schemes with sequential financing may succeed even in the absence of joint liability, though the repayment rate will be lower. In the absence of joint liability, however, group-lending with lender monitoring is unlikely to be feasible.

Asset Sales, Operating Performance and Firm Strategy: An Empirical Analysis

This paper examines the operating performance of UK firms following a decision to sell off non-financial assets as part of a new or ongoing restructuring program. We report that asset sales normally follow a sustained period of poor operating performance, and tend to occur in well-diversified firms with high levels of financial leverage. In general, asset sales lead to a significant improvement in firm operating performance. Our findings suggest that, for the UK at least, managers sell assets in response to discipline from lender monitoring, product markets and markets for managerial labour.

Value creation in corporate asset sales: The role of managerial performance and lender monitoring

Examining stockholder and bondholder wealth of acquirers and sellers, we find that asset sales are firm value enhancing for the seller but value neutral for the acquirer. Although divestitures are typically viewed as more synergistic and friendly transactions than takeovers, we find using a matched acquirer–seller sample, that the net wealth effect from the transaction is not significantly different from zero. However, those transactions that involve high- q bidders and low- q sellers create maximum value for acquirers and for the transaction as a whole. Further, low- q bidder/low- q seller transactions are value destroying. We find that seller gains are only related to the seller’s managerial performance. We document that private lender monitoring enhances transactional value in corporate divestitures. Collectively, the analysis shows that well-managed and highly monitored firms are more likely to benefit from asset sale transactions.

Equilibrium Lending Mechanism and Aggregate Activity

This paper develops a model of the market where the equilibrium lending mechanism, as well as the economy's aggregate investment and output, are endogenously determined. It focuses on two crucial elements. One is the micro theory of optimal lending mechanism. Instead of imposing a particular lending contract form exogenously, we solve for the optimal contract between a borrower and a lender designed to circumvent adverse-selection and moral-hazard problems in the model environment. The other important element is the effect of market condition on the lending mechanism. We embed the micro model of the two-agent contracting problem into a competitive market. Hence, we are able to study the interaction among market tightness, equilibrium financing mechanism and aggregate economic activity. On the optimal contract, the paper provides a formal theory that explains why some firms choose to borrow from banks, while others decide to issue bond to finance their investment. It postulates that the optimal contract is one of two kinds: either with intensive monitoring by the lender to overcome borrower's incentive problems, such as most of intermediated financing (bank or venture-capital financing), or with heavy reliance on the borrower, such as market financing. The model predicts that intermediated financing is optimal when investment returns are high, cost of lender monitoring is low, investment's liquidation value is low, and market is tight for the borrowers. On the general equilibrium effect, we show that the observation that bank lending falls relative to corporate bond issuance during recessions can be explained by movements in the economy's real factors, such as the decline in the average investment returns (which is considered as a contributing factor to the credit crunch occurred during 1990-91 recession), and paradoxically, the increase of investment demand which worsens market condition and hence intensifies the incentive problems. It can also be explained by the drop of supply, possibly brought about by a contractionary monetary policy in the short run.

Liquidity Provision, Banking, and the Role of Monitoring

This paper makes a basic point that banks' focus on information-intensive loans that require monitoring enhances their ability to provide depositors with liquidity insurance. First, monitoring enables better risk sharing between bank depositors and more risk-tolerant bank borrowers by reducing lending rate constraints which, in the absence of monitoring, would be necessary for dealing with borrower moral hazard. Second, if lender monitoring is costly and unobservable, the need for such monitoring further strengthens the bank's ability to provide liquidity insurance by reducing the threat of destabilizing trades in an anonymous market. The analysis therefore suggests an important link between bank monitoring of its borrowers that creates illiquid loans and bank providing its depositors with valuable liquidity services.

How integrated are the money market and the bank loans market within the European Union?

This paper estimates cointegration vectors of the time series of money market interest rates and bank lending rates. The study includes six member countries of the European Union (EU) and covers a period of 10 years, from 1985 to 1994. During this period, significant steps were taken that intensified financial integration in the EU, including the free flow of capital, a system of stable exchange-rate parities and the implementation of a single market for banking services. We conclude that the domestic money markets are closely linked, but the domestic banking markets are segmented. Preliminary investigation of international differences in the capital structure of firms, on the one hand, and of domestic business cycle conditions, on the other hand, do not seem to explain differences in bank spreads across countries. The results point to other directions, presumably to local market power and to differences in the role of lender monitoring.

Public Debt as a Punching Bag: An Agency Model of the Mix of Public and Private Debt

Firms with publicly-issued debt typically obtain a large fraction of their debt finance from private lenders. We show that public debt can complement private lender monitoring, in effect making private debt contracts more complete. Public debt carries few control rights, leaving bondholders vulnerable to exploitation in renegotiations between the firm and private lenders. The firm is motivated to make more efficient investment choices in order to preserve options to undertake such exploitations. Our model differs from previous literature by assuming there is no private information. Thus, the model is most relevant to the debt structure of large firms, those most likely to have a mix of public and private debt.

Corporate Restructuring in Response to Performance Decline: Impact of Ownership, Governance and Lenders *

Firms in performance decline may choose a variety of restructuring strategies for recovery with conflicting welfare implications for different stakeholders such as shareholders, lenders and managers. Choice of recovery strategies is therefore determined by the complex interplay of ownership structure, corporate governance and lender monitoring of such firms. For a sample of 297 U.K. firms experiencing relative stock return decline during 1987–93, we examine the impact of these factors as well as other control factors on their turnaround strategies. Strategy choices during the decline year and two post-decline years are modelled with logit regressions. Our results show that turnaround strategy choices are significantly influenced by both agency and control variables. While there is agreement among stakeholders on certain strategies there is also evidence of conflict of interests among them. Thereis further evidence of shifting coalitions of stakeholders for or against certain strategies.

Financial Distress, Asset Sales, and Lender Monitoring

In the United Kingdom, the main benefit from divestitures comes from the resolution of financial distress. These sales can minimize the direct and indirect costs of bankruptcy, which accounts for the positive returns to the divesting firm's shareholders.