Number Of Covenants Research Articles

Movables as Collateral and Corporate Credit: Loan-Level Evidence from Legal Reforms across Europe

Does pledging movables as collateral alter corporate borrowing? To answer this question, we study the effect of collateral law reforms on syndicated bank loans granted across nine European countries that facilitated pledging movables between 1995 and 2019, comparing them to 19 countries that did not. We differentiate firms in sectors of higher versus lower asset movability to strengthen the identification. We find that although the reforms have enabled firms in movable-intensive sectors to issue more secured loans, the average cost of the loans and the number of covenants have also increased. Channel tests suggest that banks may demand more to compensate for the potential wealth redistribution induced by newly issued secured credit, or the unique risk involved with using movables as collateral.

Confidentiality in loan credit agreements

PurposeThis study has two primary objectives. First, it analyzes the information content of confidentiality strictness in corporate loan credit agreements. Second, it examines how confidentiality strictness impacts covenant design, lending syndicate structure and loan pricing.Design/methodology/approachUsing a sample of 6,327 loan credit agreements originated by US public firms in the period of 1996–2017, this study measures the confidentiality strictness in loan contracts using textual analyses that capture the appearance of confidentiality-related words and the length of confidentiality provision. All regressions include relevant loan characteristics, firm-specific accounting variables, industry and year fixed effects. To address the endogeneity concern, the paper uses borrowing firms' rival cash holdings and R&D expenditures to instrument for confidentiality strictness in two-staged least square regressions.FindingsBorrowers which have higher R&D and operate in more competitive product markets have tighter confidentiality policies. Furthermore, this study reveals that confidentiality strictness is negatively associated with the imposition of financial covenants, especially performance covenants. Loan contracts for borrowers with stricter confidentiality on average have more relaxed covenant intensity, measured by the number of covenants. The study also shows that stricter confidentiality attracts finance companies, which have strong expertise in product markets of their parent firms, into the lending syndicate. However, confidentiality-conscious borrowers with higher degree of information asymmetry are subject to higher loan spreads.Originality/valueThis study provides the first examination of confidentiality policies in loan contracts and supports the idea that loan provisions are not simply made of “boilerplate” language. The results suggest that, for confidentiality-sensitive borrowers, the greater exposure to product market competition helps control managerial slack and substitute monitoring from financial markets.

Friends with Values – The Impact of Reputable Lead Arranger and External Auditor on Borrower’s Loan Terms

This paper explores the certification effect of both reputable lead bank, and external auditor on various syndicated loan terms—the yield spread, loan maturity, amount, and the number of covenants. The results from two-way interaction model support significant positive certification effects. In the presence of Top 10 lead arrangers, borrowers benefit from lower loan spread, reduced number of financial covenants, extended maturity, and larger loan amount. The relationship with a reputable external auditor elevates the certification effect. The study extends prior literature by analyzing non-price terms. The results suggest that for informationally disadvantaged parties, dual certification seems to add value.

Short-term institutional investors and agency costs of debt

We conjecture that the presence of short-term institutional investors exacerbates agency conflicts between shareholders and creditors because short-term institutions might force firm managers to take myopic actions. Using the data on private debt to U.S. firms, we find that the investment horizons of institutional investors are negatively correlated with the number of loan covenants and loan spreads. We also document that short-term (long-term) institutional ownership is positively (negatively) correlated with the number of covenants, and that banks charge higher spreads on loans issued to firms with more short-term institutional ownership. These findings are consistent with our conjecture.

Bank Market Power and Loan Contracts: Empirical Evidence

Using a sample of syndicated loan facilities granted to US corporate borrowers from 1987 to 2013, we directly gauge the lead banks’ market power, and test its effects on both price and non‐price terms in loan contracts. We find that bank market power is positively correlated with loan spreads, and the positive relation holds for both non‐relationship loans and relationship loans. In particular, we report that, for relationship loans, lending banks charge lower loan price for borrowing firms with lower switching cost. We further employ a framework accommodating the joint determination of loan contractual terms, and document that the lead banks’ market power is positively correlated with collateral and negatively correlated with loan maturity. In addition, we report a significant and negative relationship between banking power and the number of covenants in loan contracts, and the negative relationship is stronger for relationship loans.

Private Lenderss Demand for Audit

We study the demand for audit in private lending agreements by recording whether the lending agreement includes an obligation on the borrower’s auditor to verify compliance with the financial covenants in the loan contract. We find that auditor covenant compliance obligations are significantly associated with the level of adjustments of net income definitions, suggesting that auditors play an important monitoring role in private debt markets by certifying non-GAAP accounting figures. Increased auditor obligations to lenders are also positively associated with the number of covenants, the level of intangibility of the borrower’s assets, the size of the loan syndicate, loan maturity, and the presence of accounting-based performance pricing provisions. As well as offering a new measure of private lenders’ demand for audit, we provide evidence of the audit market playing an important role in enhancing efficient contracting.

Why Do Loans Contain Covenants? Evidence from Lending Relationships

Despite the importance of banks' role as delegated monitors, little is known about how non-price terms of loan contracts are structured to optimize information production in a lending relationship. Using a large sample of corporate loans, this paper examines the effect of relationship lending on covenant choice. Consistent with information asymmetry theories, covenant tightness is relaxed over the duration of a relationship, especially for opaque borrowers. In contrast, the effect of lending relationship intensity on the number of covenants included in a loan follows an inverted U shape. I discuss potential explanations for this finding.

The Impact of Corporate Governance on Covenant Use in Private Debt Contracts

This thesis examines the association between corporate governance and the restrictiveness of covenants used in private debt contracts in the U.S. Both corporate governance and covenants have been shown to play a role in mitigating agency problems associated with debt. A complementary relationship may be expected between these two monitoring mechanisms but it is unclear whether corporate governance has any influence on the way covenants are used to mitigate debtholder-shareholder conflicts. Using an agency framework, this thesis argues that debtholders will consider a firm’s corporate governance when estimating its potential agency costs. The central hypothesis is that, ceteris paribus, firms with stronger corporate governance will be perceived by debtholders to be less likely to engage in ex-post opportunistic activities that will expropriate wealth and reduce the value of the claims, thereby reducing the need to use particularly restrictive covenants. The strength of corporate governance will be measured using both a governance index/score as well as firm specific characteristics such as board independence and board expertise. Several measures of covenants restrictiveness will be employed including the number of covenants, a covenant-intensity-index, a covenant slack and contract-specific accounting measurement requirements such as the use of fixed or rolling GAAP. This thesis also explores the relation between corporate governance and performance pricing, a contractual feature that is often included, in addition to covenants, in private debt contracts. Given that performance pricing helps address deterioration in a firm’s future credit quality by directly linking ex-ante pricing of debt with the firm’s ex-post performance, the expectation is it complements the role of covenants, particularly in cases where covenants are less restrictive. Accordingly, it is hypothesised that, ceteris paribus, performance pricing is more likely to be included in the debt contracts of firms with stronger corporate governance. Some preliminary results will be presented at the symposium.