Management quality and the cost of debt: Does management matter to lenders?

This paper investigates the effect of organizational capital, typified by various management practices within a firm, on the cost of external debt financing. Using a sample of medium-sized manufacturing firms in the US, we find that better management practices enhance a firm’s external financing capacity by lowering the firm’s cost of bank loans. We do not find any evidence that the lower loan cost of a high-quality-management firm is associated with more restrictive non-price contract terms such as greater collateral requirements and stricter covenants. These results suggest that banks explicitly take into account the risk arising from poor management practices when pricing and designing debt contracts.     

Debt maturity dispersion and the cost of bank loans

This paper examines the relation between corporate debt maturity dispersion and the pricing and terms of bank loans. Analyzing a sample of U.S. bank loans from 2002 to 2016, we find that firms with a dispersed debt maturity structure pay a lower interest rate. The rate-reduction effect is significant only for firms without a credit rating. For these firms, spreading debt maturity dates also results in lower commitment fees, fewer covenant restrictions, and less collateral in their loan contracts. The impact of debt maturity dispersion on the pricing and structure of bank loans is stronger when borrowers have higher rollover risk or when the need for monitoring is greater. Our results suggest that dispersion in debt maturity structure mitigates the agency problem associated with shareholder–creditor conflicts by reducing rollover risk and alleviating the need for monitoring, which results in borrowers receiving more favorable terms in loan contracts.     

Corporate governance and the dynamics of capital structure: New evidence

The effects of corporate governance on optimal capital structure choices have been well documented, though without offering empirical evidence about the impact of corporate governance quality on the adjustment speed toward an optimal capital structure. This study simultaneously considers two effects of debt originating from agency theory—the takeover defense and the disciplinary effects of debt—on the speed of adjustment to the optimal capital structure. Corporate governance has a distinct effect on the speed of capital structure adjustment: weak governance firms that are underlevered tend to adjust slowly to the optimal capital structure, because the costs of the disciplinary role of debt outweigh the benefits of using debt as a takeover defense tool. Although overlevered weak governance firms also adjust slowly, they do so because they are reluctant to decrease their leverage toward the target level to deter potential raiders, especially if they face a serious takeover threat. Therefore, this study finds that both overlevered and underlevered firms with weak governance adjust slowly toward their target debt levels, though with different motivations.     

Intellectual property rights reform and the cost of corporate debt

This paper investigates the role of intellectual property rights (IPR) protection on the cost of bank loans for firms in 48 countries. Using substantial reforms of patent rights as a source of identifying variation, the paper provides strong evidence that borrowers from countries that underwent IPR reform experience significant reductions in the cost of bank debt. Importantly, the effects of IPR reform on loan rates are significantly larger in industries that are more IP-intensive. Additional analysis shows that in the wake of reforms borrowers obtain larger size loans, which indicates that improvements in IPR are associated with greater credit availability. IPR reform also increases foreign lenders participation in loan syndicates. Overall, these findings suggest that legal protection afforded to intellectual property has a significant impact on the cost of corporate borrowing and the ability of innovative firms to raise debt capital.     

TAKEOVER EXPOSURE, AGENCY, AND THE CHOICE BETWEEN PRIVATE AND PUBLIC DEBT

We examine how governance characteristics are related to the corporate choice between public and private debt. We find that firms with fewer takeover defenses and larger outside blockholder ownership are more likely to borrow from banks and to issue 144A debt. We also document that public debt cost is more sensitive to takeover exposure than bank debt cost. These results are consistent with the hypothesis that banks mitigate the expected negative effect of takeovers on debt value through covenants and debt renegotiations. Moreover, we show that firms with weaker internal monitoring are less likely to borrow from banks.     

MANAGERIAL OWNERSHIP,TAKEOVER DEFENSES,AND DEBT FINANCING

We examine the effect of agency conflicts on debt financing and show that managerial ownership and its interaction with takeover defenses affect these decisions. We find that (1) the relation between leverage and takeover defenses becomes insignificant when we control for the interaction of these defenses with managerial ownership, and (2) firms with large managerial ownership operate at high debt levels unless they have a large number of takeover defenses. Therefore, a two‐dimensional aspect of governance that includes the interaction between managerial ownership and takeover defenses is useful in understanding the effect of agency conflicts on firms' debt financing decisions.     

Firm location and corporate debt

This study examines the influence of a firm’s geographical location on corporate debt and provides evidence that the higher cost of collecting information on firms distant from urban areas has significant implications on a wide array of corporate debt characteristics. We find that rural firms face higher debt yield spreads and attract smaller and less prestigious bank syndicates than urban firms. Rural firms attempt to reduce their informational disadvantage by relying more on relationship banking. Our results on the effect of location on corporate debt are robust to the inclusion of an extensive set of firm and issue characteristics.     

Waiving Technical Default: The Role of Agency Costs and Bank Regulations

Abstract:  This paper examines whether the characteristics of banks and borrowers are associated with banks' decisions to waive violations of debt covenants. The findings suggest that banks possess sufficient private information about firms, and they use this information in their waiver decisions. Banks' decisions to waive violations vary with the borrowers' agency costs, debt features, the banks' characteristics and regulatory circumstances, and the bank-firm business relationship. There is no evidence that syndicated loans, bank structure, and adverse economic conditions are significant determinants of the waiver decision. Research findings offer valuable insight into the theoretical and practical implications of debt covenants and agency costs.     

Corporate fraud and bank loans: Evidence from china

Receiving punishment from regulators for corporate fraud can affect financing contracts between a firm and its bank, as both the firm’s credit risk and information risk increase after punishment. By focusing on Chinese firms’ borrowing behavior after events of corporate fraud, we find that firms’ bank loans after punishment are not only significantly lower, but are also less than those for non-fraudulent firms. In addition, loan interest rates after punishment are not only higher than before, but also higher than those for their non-fraudulent counterparts. In addition, we find that corporate fraud indirectly destabilizes the “performance-bank loan” relationship. Our results suggest that corporate fraud negatively affects a firm’s ability to source debt financing, which provides new evidence about the economic consequences of fraud.     

IPO underwriting and subsequent lending

This study investigates the relation between IPO underwriting and subsequent lending. We find that when a bank underwrites a firm’s IPO, the bank is more likely to provide the issuer with future loans at a lower cost, compared to banks without an IPO underwriting relationship. The evidence also suggests that the underwriting banks share information surplus with the IPO firms in the post-IPO loans, supporting the cost-saving hypothesis. Overall, the evidence for the relation between prior IPO underwriting and subsequent lending supports the notion that firms can derive value from investment bank relationships.     

Bank competition and the cost of bank loans

I comprehensively study the effect of bank competition on the cost of bank loans using U.S. bank loan data from 1995 to 2010. The cost of bank loans is analyzed with regard to loan spreads and covenant intensity. I show that loan spreads and covenant intensity are negatively related to bank competition. I also find that non-investment grade and financially constrained firms benefit more from bank competition than investment grade and financially unconstrained firms do. Lenders with low market power are more willing to reduce loan price than lenders with high market power in competitive lending markets. The results suggest that lenders give favorable loan terms to borrowers in competitive loan markets.     

Does corporate governance matter in competitive industries?

By reducing the threat of a hostile takeover, business combination (BC) laws weaken corporate governance and increase the opportunity for managerial slack. Consistent with the notion that competition mitigates managerial slack, we find that while firms in non-competitive industries experience a significant drop in operating performance after the laws’ passage, firms in competitive industries experience no significant effect. When we examine which agency problem competition mitigates, we find evidence in support of a “quiet-life” hypothesis. Input costs, wages, and overhead costs all increase after the laws’ passage, and only so in non-competitive industries. Similarly, when we conduct event studies around the dates of the first newspaper reports about the BC laws, we find that while firms in non-competitive industries experience a significant stock price decline, firms in competitive industries experience a small and insignificant stock price impact.     

Bank Monitoring and Environmental Risk

Abstract:  Loan announcement effects for 152 Canadian companies are examined to investigate the efficiency of monitoring by banks facing lender environmental liability. Market reaction to the announcement of bank debt to 'environmental' firms is more positive and significant than for 'non-environmental' firms and, for firms in industries with a higher likelihood of experiencing spill events, is more positive and significant, reinforcing earlier results that establish a relationship between specific loan/borrower characteristics and announcement period excess returns and providing further evidence on the 'uniqueness' of bank loans by demonstrating the superior ability of banks to monitor corporate borrowers exposed to environmental liability.     

The Effects of Corporate and Country Sustainability Characteristics on The Cost of Debt: An International Investigation

We investigate the relationship between corporate and country sustainability on the cost of bank loans. We look into 470 loan agreements signed between 2005 and 2012 with borrowers based in 28 different countries across the world and operating in all major industries. Our principal findings reveal that country sustainability, relating to both social and environmental frameworks, has a statistically and economically impactful effect on direct financing of economic activity. An increase of one unit in a country's sustainability score is associated with an average decrease in the cost of debt by 64 basis points. Our international analysis shows that the environmental dimension of a country's institutional framework is approximately twice as impactful as the social dimension, when it comes to determining the cost of corporate loans. On the other hand, we find no conclusive evidence that firm‐level sustainability influences the interest rates charged to borrowing firms by banks. Our main findings survive a battery of robustness tests and additional analyses concerning subsamples, alternative sustainability metrics and the effects of financial crisis.     

Competition and the cost of debt

This paper empirically shows that the cost of bank debt is systematically higher for firms that operate in competitive product markets. Using various proxies for product market competition, and reductions of import tariff rates to capture exogenous changes to a firm's competitive environment, I find that competition has a significantly positive effect on the cost of bank debt. Moreover, the analysis reveals that the effect of competition is greater in industries in which small firms face financially strong rivals, in industries with intense strategic interactions between firms, and in illiquid industries. Overall, these findings suggest that banks price financial contracts by taking into account the risk that arises from product market competition.     

Local product market competition and bank loans

We investigate the influences of local product market competition on the cost of private debt. Our evidence suggests that the cost of bank loans is significantly higher for firms headquartered in states with greater local product market competition measured by the Herfindahl-Hirschman Index for resident industries. To establish causality, we examine the recognition of the Inevitable Disclosure Doctrine and firm relocations to identify exogenous shocks to local product market competition. We find that the cost of bank loans is lower for firms facing less intense local product market competition after the adoption of IDD and higher for firms relocated to states with more competitive product markets. The results imply that banks value the characteristics of a firm's local product market when approving loan contracts.     

Multiple corporate governance attributes and the cost of capital – Evidence from Germany

This paper investigates the extent to which corporate governance affects the cost of debt and equity capital of German exchange-listed companies. I examine corporate governance along three dimensions: financial information quality, ownership structure and board structure. The results suggest that firms with high levels of financial transparency and bonus compensations face lower cost of equity. In addition, block ownership is negatively related to firms' cost of equity when the blockholders are other firms, managers or founding-family members. Consistent with the conjecture that agency costs increase with firm size, I find significant cost of debt effects only in the largest German companies. Here, the creditors demand lower cost of debt from firms with block ownerships held by corporations or banks. My findings demonstrate that a uniform set of governance attributes is unlikely to satisfy suppliers of debt and equity capital equally.     

Product market relationships and cost of bank loans: Evidence from strategic alliances

This paper examines the relation between strategic alliances and non-financial firms’ bank loan financing. We construct several measures to capture firms’ alliance activities. The key finding is that borrowing firms with active alliance involvement experience lower cost of bank loans. The reduction of borrowing cost is strongest for financially unconstrained firms and firms with high G-index and intensive monitoring from institutional investors. We also relate various characteristics of alliance agreements to the cost of bank borrowing, and find evidence supporting market power hypothesis and organizational flexibility hypothesis. We further report that allying with a prestigious partner (i.e., S&P 1500 firms) provides certification effect that lowers bank loan cost. In addition, firms positioned in the center of the alliance network enjoy lower cost of bank loans. Lastly, we document that firms engaging in alliance activities expand their debt capacity and are less likely to use collaterals and covenants in their bank loan contracts.     

The unintended consequence of collateral-based financing: Evidence from corporate cost behavior

This paper examines how real estate appreciation correspondingly changes collateral value, which affects debt structure choices and consequent operating decisions. Specifically, we explore whether collateral-based financing provides a link between real estate values and corporate cost behavior. Our baseline results show that an appreciation of a firm’s real estate assets alleviates its cost stickiness. A further analysis shows that this influence is stronger for firms with less prior bank debt, less dependence on external financing, and a lower leverage ratio. We also observe that the impact of collateral shocks on cost stickiness is more pronounced when selling, general and administrative (SG&A) costs create less future value for mature firms and for firms with weaker external governance. Collectively, our results support the argument that an increase in bank debt arising from collateral value appreciation mitigates agency problems and thus lessens cost stickiness.     

Financial Reporting Quality,Debt Maturity,and the Cost of Debt: Evidence from China

This paper investigates the influence of different financing channels—bond issuance or bank loans—as well as debt maturity and the quality of financial reporting on the cost of debt in China. The authors find that conservative accounting is an important characteristic of high-quality financial reporting that can reduce the cost of longer maturity debt such as bank loans and bonds. Even state-owned enterprises, which have fewer financial constraints than non-state-owned enterprises, benefit from accounting conservatism's ability to reduce financial costs. Moreover, the findings indicate that bond investors are concerned about the issuer's fundamentals, while banks are more likely to focus on the operation and bankruptcy risk of borrowers.