Loan Spreads Research Articles

The Value of a Neighbor: The Real Impact of Neighboring Firm Valuations

A firm’s investment responds to the stock valuations of other firms headquartered nearby. This response is stronger among financially constrained firms, is robust to controlling for the investment of other firms in the region, and is driven by the valuations of large firms. These findings are difficult to reconcile with existing theories that link investment opportunities to firm valuations, but instead suggest that a firm’s access to credit rises and falls with the valuations of other firms located nearby. Consistent with this explanation, financially constrained firms issue more debt and receive lower loan spreads when neighboring firms have higher valuations.

Does Firms’ Equity Financing Benefit Debtholders? Evidence from Private Placements of Equity

We examine how private placements of equity (PPEs) affect debtholder wealth. We find that banks charge higher loan spreads, require more collateral, and impose stricter covenants for firms conducting PPEs. The results are more pronounced for firms without a value-enhancing PPE feature, particularly those with poorer governance and higher information asymmetry. These firms also invest less efficiently and underperform in the post-placement period and realize more negative bond and stock returns around PPE (post-placement M&A) announcement dates. Thus, issuers’ managerial entrenchment problems are the main source of debtholders’ loss in PPEs, and lenders use such information in adjusting lending terms.

Greenwashing and Bank Loan Contracting: Does Environmental Disclosure Quality Matter to Creditors?

We provide novel evidence on the nexus between a firm’s symbolic environmental disclosure to present an overly responsible public image, i.e., greenwashing, and the structure and design of its bank-loan contracts. Our evidence indicates that while greenwashing is associated with lower loan spread, creditors use a complex contract design rather than a single price measure to extract an appropriate expected return from greenwashing firms. Specifically, lenders appear to charge higher fees and employ stricter non-price contract terms to upend the impact of lower spread on their bottom line. Our findings highlight a unique mechanism through which the superior monitoring and information processing capabilities of private lenders could be deployed as a governance mechanism to guard against greenwashing without stifling firms’ external financial access.

FASB Disclosure and Bank Loan Contracting: Evidence from Derivative and Hedging Footnotes

This paper is the first to study the effect of enhanced derivative and hedging footnote disclosures on information asymmetries in bank loan contracting. Utilizing the issuance of SFAS 161, we employ a difference-in-differences design to evaluate 3,732 bank loans for 1,126 firms in the United States between 2002 and 2017. We find that borrowers whose disclosures change more after SFAS 161 enjoy lower loan spreads and fewer general covenants and have more but less stringent financial covenants. Further analyses indicate that the increased qualitative and quantitative disclosures and use of tabular display after SFAS 161 matter most for lenders in loan contracting. Our empirical results also show that the changes in contract terms are driven by the abatement of information uncertainty regarding the firm value and the improvement in firm’s disclosure quality after SFAS 161, which helps explain how enhanced DH disclosures affect information asymmetries in bank loan contracting.

Bank Safety-oriented Culture and Lending Decisions

In this study, we investigate the effects of bank safety-oriented culture on loan contracts. We propose a new measure that derives a bank’s safety-oriented culture from its business model. We provide several validation tests to confirm that our measure can represent the safety-oriented culture of banks. Our empirical results show that banks with a safety-oriented culture increase the probability of signing a contract with low risk borrowers and that they charge lower loan spreads. We also find that these banks ask for more loan covenants to protect their creditor’s rights. Finally, banks with a safety-oriented culture suffer less from borrowers’ defaults and have higher market responses around the dates of loan announcements. Also, our findings reject the alternative hypothesis that banks with a safety-oriented culture only accept less risky lending due to their conservative risk attitude, thus destroying market value for banks.

The Impact of Securities Regulation on New Keynesian Firms

Borrowing firms resetting output prices infrequently are less able to insulate their profits from economic shocks, the impact of which on performance is costly for lenders to verify. If securities regulation is lenient, sticky-price firms might face greater financial frictions due to managerial misreporting. We document that S&P 500 firms with stickier prices paid lower loan spreads and provided collateral less often following the passage of Sarbanes-Oxley Act (SOX), and the results are robust to using staggered implementations of Section 404 to isolate the effects that were uniquely due to SOX. Firms with stickier prices are negatively associated with daily returns around the Enron scandal but positively associated with returns around the SEC's approval of the change in listing requirements. We develop a New Keynesian model of an economy in which firms feature differential output-price stickiness. The model mirrors both pre- and post-SOX scenarios and shows that when paying higher credit spreads, firms with stickier prices have lower debt capacity, are endogenously more volatile in equity returns, and display higher capital-investment and stock-price sensitivities to monetary policy shocks. Our further empirical analyses yield results that are in line with these model predictions.

Business Strategy and Cost of Bank Loans

Following Miles and Snow’s Business Strategy (BS) topology, we find that banks impose relatively higher loan spreads for the firms that follow an Innovation-Oriented Business Strategy (IOBS). We further document that IOBS is positively associated with corporate risk measures such as variances in equity returns and returns on assets. Overall, our findings suggest that banks charge a higher cost of debt in anticipation of borrowers’ payback riskiness from an IOBS.

Tacit collusion among dominant banks: Evidence from round-yard loan pricing

While there is no apparent reason for loan spreads to cluster at certain numbers, we find that around 70% of loans have round-yard spreads (i.e., multiples of 25 basis points). We hypothesize that dominant banks implicitly collude by using the round-yards as focal pricing points when negotiating with their borrowers. The tacit collusion leads to higher spreads and total costs of the round-yard-priced loans than non-round-yard-priced loans. Consistent with our tacit collusion hypothesis, dominant banks round up rather than round down loan spreads to the multiples of yards. Moreover, round-yard pricing is more prevalent among lower-quality and non-repeat borrowers. Overall, we provide the first evidence that dominant banks use round-yard pricing as an effective tool for tacit collusion in the loan market.

Financial analysts' career concerns and the cost of private debt

Career-concerned analysts are averse to firm risk. Not only does higher firm risk require more effort to analyze the firm, thus constraining analysts' ability to earn more remuneration through covering more firms, but it also jeopardizes their research quality and career advancement. As such, career concerns incentivize analysts to pressure firms to undertake risk-management activities, thus leading to a lower cost of debt. Consistent with our hypothesis, we find a negative association between analyst career concerns and bank loan spreads. In addition, our mediation analysis suggests that this association is achieved through the channel of reducing firm risk. Additional tests suggest that the effect of analyst career concerns on loan spreads is more pronounced for firms with higher analyst coverage. Our study is the first to identify the demand for risk management as a key channel through which analysts help reduce the cost of debt.

Ownership Structure, Antitakeover Provisions, and the Cost of Debt

We investigate the importance of ownership structure when assessing the impacts of antitakeover provisions (ATPs) on debtholder wealth. Using a regression discontinuity design, we find that loan spreads significantly decrease (increase) for family (nonfamily) firms after the passage of close-call shareholder proposals to remove ATPs. The results are similar when bond announcement returns are used as an alternative measure of debtholder wealth. The decrease (increase) in loan spreads is more evident when family (nonfamily) firms have lower (higher) asset substitution concerns, when they face more (less) intense product market competition, and when their top ten institutions hold smaller (larger) ownership.

Audit Profession Development and Bank Loan Contracting

SUMMARY This study examines the relation between country-level audit profession development (APD) and bank loan contracting around the world. Using a sample of bank loan data from 35 countries, we find that stronger APD is associated with more favorable loan terms, such as lower loan spreads, fewer covenants, and larger loan amounts. These effects are stronger in countries with a weaker rule of law. We also find that stronger APD attracts significantly more lenders participating in loans and more foreign lenders leading loans. A breakdown of APD into three subcategories, namely, auditor education, auditor independence and liability, and auditor oversight, reveals that all three influence various contracting terms. We also provide evidence that stronger APD is associated with a higher degree of timely loss recognition. Collectively, our findings show that APD improves bank loan contracting terms. Data Availability: Data are publicly available from the sources mentioned in the manuscript. JEL Classification: F34; K20; M41; M42.

Leveraged Loans: Is High Leverage Risk Priced in?

The economic downturn caused by the COVID-19 pandemic accentuates extant concerns about the leveraged loan market. Using a novel dataset, we show that leveraged loan spreads have declined for nonbank-facilities since the introduction of the Interagency Guidance on Leveraged Lending (IGLL) and the ensuing “frequently asked questions for implementing the March 2013 guidance”. The decline in leveraged loan spreads is significant for highly leveraged borrowers, especially when involving term loans. We further demonstrate that risk shifting issues associated with the high level of Collateralized Loan Obligations issuance strongly explain the decline of nonbank leveraged loan spreads. In addition, a higher degree of information asymmetry, driven by an increase in covenant-lite loan issuance and weaker investor protection, are strongly associated with the narrowed leverage risk premium.

Does trust matter for the cost of bank loans?

This paper extends the literature related to the role of trust on economic activity, focusing on the influence of trust on lender-borrower relationships and analysing its effect on the interest rate spread for a sample of 20,699 loans from 47 countries over the period 2003–2018. We consider not just the role of trust, but also how its effect is moderated by the country's legal enforcement and degree of economic development. The results show that trust has no effect on loan spreads. However, trust is found to reduce loan spreads when a country's formal institutions are weak, in line with the existence of a substitutive effect between formal and informal institutions in reducing interest rates. As regards the degree of economic development, our results show that both trust and legal enforcement have a greater influence on the interest rate spread of bank loans in countries with a lower level of economic development.

Deregulation of short-selling constraints and cost of bank loans: Evidence from a quasi-natural experiment

Investors can sell short on designated stocks on China stock market since March 2010 when the CSRC relieved the short-selling constraints, which provides a quasi-natural experiment to examine how short selling affects the bank loan contracts. Using the 13,755 bank loan contracts from Chinese listed firms during 2007–2014, our results show that bank loan spreads decline significantly for treated firms compared to control firms after removing the short-selling constraints. Further, we find that the results are driven mainly by firms far from bank geographically, firms haven't relationship with bank in the prior 3 years, and firms with high default risk. Our findings provide further insight into the relationship between stock market and debt market, and are helpful to understand economic effect of short selling on the decision-making of other market participants.

Environmental regulation and the cost of bank loans: International evidence

Using a sample of 27 countries between 1990 and 2014, we find that banks charge higher interest rates and adjust other contractual features of their loans when lending to firms facing more stringent environmental regulations. Our evidence suggests that lenders’ concerns about the increase in environmental liabilities resulting from regulations is driving the results. Specifically, we show that firms facing such regulations have fewer participants in their loan syndicates, higher bankruptcy risk, and lower credit ratings, despite reducing their leverage. Overall, our results indicate that the observed higher loan spread is the result of environmentally sensitive lending practices by banks.

Political Uncertainty and Bank Loan Contracts: Does Government Quality Matter?

We investigate the relation between political uncertainty and bank loan spreads using a sample of loan contracts for the G20 firms during the period from 1982 to 2015. We find that banks charge firms higher loan spreads and require more covenants during election years when domestic political risks are elevated. Greater differences in the support ratios of opinion polls on candidates lead to the lower cost of bank loans. This political effect also lessens when the government quality of the borrower’s country is better than that of the lender’s country. Better quality government can lower the political risk component of bank loan spreads.

Partisanship in Loan Pricing

Do partisan perceptions influence the way investors price securities? Using voter registration data of bankers originating large corporate loans, we show that misaligned bankers, i.e., whose party differs from that of the U.S. President, charge 7\% higher loan spreads than aligned bankers. This effect is amplified during periods of intense partisan conflicts, when left- and right-wing media strongly disagree over economic conditions, and for borrowers with limited outside options. Bankers and borrowers do not seem to match on political affiliations. Our results are not driven by bank or borrower fundamentals, but suggest misaligned bankers have more pessimistic outlook than aligned bankers.

Generalist CEOs and Credit Ratings

A recent trend is that firms prefer to hire generalist CEOs with transferable skills (across firms or industries) over hiring specialist CEOs, but the consequences of this trend are unclear. In this study, we examine whether credit rating agencies consider a CEO’s general skills as a credit risk factor when assessing an entity’s overall creditworthiness. We predict and find that generalist CEOs are associated with lower credit ratings, suggesting that the presence of generalist CEOs is a significant credit rating factor. We also find that generalist CEOs are likely to take on more risks, which leads to more volatile performance ex post, and our path analyses confirm default risks is a significant mediator between credit ratings and CEOs’ general skills. Our results hold in the presence of additional controls (e.g., CEO characteristics and corporate governance), when applying different fixed-effect models and different matching methods, and for a subsample with forced CEO turnover. We also find that the negative relationship is attenuated for R&D-intensive firms and firms in competitive industries. Last, we provide evidence that firms with generalist CEOs face higher borrowing costs, such as bond yields and syndicated loan spreads. Overall, our results contribute to a growing literature on the costs and benefits of hiring generalist CEOs, by providing a full picture of why hiring a generalist CEO may benefit shareholders but also cause misalignments with bondholders’ interests.

Do Banks Value Borrowers' Environmental Record? Evidence from Financial Contracts

Banks play a unique role in society. They not only maximize profits but also consider the interests of stakeholders. We investigate whether banks consider firms’ pollution records in their lending decisions. The evidence shows that banks offer significantly higher loan spreads, higher total borrowing costs, shorter loan maturities, and greater collateral to firms with higher levels of chemical pollution. The costly effects are stronger for borrowers with greater risk and weaker corporate governance. Further, the results show that banks with higher social responsibility account for their borrowers’ environmental performance and charge higher loan spreads to those with poor performance. These results support the idea that banks with higher social responsibility can promote the practice of business ethics in firms.

Do CSR Ratings Affect Loan Spreads? Evidence from European Syndicated Loan Market

We investigate whether corporate social responsibility (CSR) ratings affect the syndicated loan spreads paid by European listed firms. By performing ordinary least squares (OLS) pooled regressions on a sample of 1101 syndicated loans granted to European companies, we find evidence that borrowers’ CSR ratings have a significant impact on loan spreads. However, the relationship between CSR ratings and loan spreads is quite complex. Low CSR-rated firms pay higher loan spreads than better CSR-rated firms, but high CSR ratings are not always rewarded by lenders. The benefits of a high CSR rating level are significant only for firms located in countries that pay great attention to sustainability issues. Overall, our work provides a key to reconciling the mixed results obtained in the empirical literature, as we find evidence of a significant lack of homogeneity within the European Union countries regarding the relationship between CSR performance and the cost of debt financing.