Monitoring and bank loan pricing

In this paper, we examine the influence of contract costs on the pricing of bank loans. We find that the loan spread depends on a bank's screening and monitoring incentives, which varies across differentially regulated classes of banks. This leads to significant price disparities in the loan market. In particular, the US branches of Japanese banks participate in syndicated lending to US firms that charge significantly higher spreads compared to syndicated loans to US firms without Japanese participation. This pricing disparity is primarily due to regulatory differences. We also find that as specialized intermediaries, banks price loans based primarily on their own monitoring.     

Auditor size, tenure, and bank loan pricing

Using a large sample of U.S. bank loan data from 1996 to 2008, we investigate the relation between two auditor characteristics, namely, auditor size and tenure, and loan interest rates. Our results show the following: First, we find that the loan interest rate is significantly lower for borrowers with prestigious Big 4 auditors than for borrowers with non-Big 4 auditors. Second, we find that auditor tenure is negatively associated with the loan interest rate, suggesting that a long client–auditor relationship lowers the loan borrowing cost. Third, we find that the negative association between auditor size and loan rate is more pronounced for transaction-based term loans than for relationship-based revolving loans. Fourth, our sub-period tests show that our results are driven by the post-Sarbanes–Oxley Act period. Our study provides direct evidence that auditor size and tenure are incremental credit risk-reducing factors in the bank loan market.     

Bankruptcy,overlapping directors,and bank loan pricing

Using a sample of loan facilities borrowed by firms that share directors with bankrupt firms, this study investigates whether the overlapping directors are a transmission channel of the bankruptcy contagion effect in the bank loan market and, if so, what the underlying mechanism is. We find that firms are charged higher loan spreads in the period following the bankruptcy filing of a firm with a common director and that overlapping directors are a relevant channel for the bankruptcy contagion effect, in addition to other channels identified in literature. We also find that the negative contagion effect on loan pricing is most likely driven by the overlapping directors' reputation loss due to their involvement in bankruptcy events, and not by competing hypotheses, such as director distraction and director career concern/experience. Further analyses reveal that the adverse contagion impact on loan spreads is more pronounced when overlapping directors have greater influence over corporate policies or when their reputation is more seriously damaged. Meanwhile, the contagion effect is mitigated when interlocked firms have a higher-quality board. These results further support our evidence of the director reputation loss hypothesis. We strengthen the identification strategy to establish causality. In sum, our study identifies common directors as a channel of bankruptcy contagion effects on loan pricing and director reputation loss as an underlying mechanism.     

An economic rationale for the pricing structure of bank loan commitments

An economic rationale is provided for the competitive equilibrium deployment of commitment and usage fees in loan commitment pricing. It is shown that, under perfect information, assessing both fees rather than just one permits optimal risk sharing. When the borrower is privately informed about its probability of future commitment utilization, commitment and usage fees can be used to induce borrowers to identify themselves by self-selection through contract choice. The equilibrium characterized here is dissipative and thus raises the usual existence questions which are addressed in the paper.     

Bank loan loss accounting treatments,credit cycles and crash risk

Banks that follow conditional conservatism in their loan loss accounting treatments benefit from a reduction in crash risk. The key discretionary loan loss accounting channels are provisions and allowances. We show that conditional conservatism reduces crash risk of small banks during periods of credit contraction and boom. Interestingly, for large banks, crash risk is not reduced by more conservative accounting even for those with higher levels of opacity. Hence regulation prompting for more conservative bank loan loss accounting does not present a significant opportunity to limit systemic effects arising from abrupt price declines in the stocks of large banks.     

The pricing of conservative accounting and the measurement of conservatism at the firm-year level

This paper analyzes the relation between equity prices and conditional conservatism and introduces a new measure of conservatism at the firm-year level. We show that the asymmetric properties of conservative accounting, the existence of non-accounting sources of information, and the properties of GAAP related to special items combine to generate a nonlinear relation between unexpected equity returns and earnings news (the shock to expected current and future earnings). Based on this model, we construct a conservatism ratio (CR) defined as the ratio of the current earnings shock to earnings news. CR measures the proportion of the total shock to expected current and future earnings recognized in current year earnings. Ranking firms according to CR, we show empirically that higher CR firms have more leverage, increased volatility of returns, more incidence of losses, more negative accruals, and increased volatility of earnings and accruals, consistent with the literature on conservative accounting.     

Publicly traded versus privately held: implications for conditional conservatism in bank accounting

Compared with privately held banks, publicly traded banks face greater agency costs because of greater separation of ownership and control but enjoy greater benefits from access to the equity capital market. Differences in control and capital market access influence public versus private banks’ accounting. We predict and find that public banks exhibit greater degrees of conditional conservatism (asymmetric timeliness of the recognition of losses versus gains in accounting income) than private banks. We predict and find that public banks recognize more timely earnings declines, less timely earnings increases, and larger and more timely loan losses. Although public ownership gives managers greater ability and incentive to exercise income-increasing accounting, our findings show that the demand for conservatism dominates within public banks and that the demand for conservatism is greater among public banks than private banks. Our results provide insights for accounting and finance academics, bank managers, auditors, and regulators concerning the effects of ownership structure on conditional conservatism in banks’ financial reporting.

Share repurchases and accounting conservatism

Review of Quantitative Finance and Accounting - The prior literature indicates that financial policy (e.g., payout policy) as well as accounting policy (e.g., conservatism) can be used to address...     

Cultural tightness and accounting conservatism

This study investigates the effect of intrastate cultural tightness-looseness (CTL) on accounting conservatism, using firms located in 50 states of the United States, from 1988 to 2016. It finds that firms located in culturally tight states prefer to take a cautious approach to reduce uncertainty of future economic events by increasing accounting conservatism compared to those located in culturally loose states. Moreover, we find that the positive effect of cultural tightness on accounting conservatism is more pronounced as product market competition increases. Taken together, our findings provide evidence that intrastate CTL has differential impacts on accounting conservatism in the same national culture, and product competition strategically reinforces the positive effect of CTL on accounting conservatism.     

Competition,transmission and bank pricing policies: Evidence from Belgian loan and deposit markets

This paper addresses the pass-through from market interest rates to retail bank interest rates. The paper advocates a heterogeneous approach and applies it to the Belgian banking market. A substantial proportion of the heterogeneity in bank pricing policies can be explained by the bank lending channel and the relative market power hypothesis. The results also suggest that the long-term pass-through is typically less than one-for-one, rejecting the completeness hypothesis. While there is no convincing evidence for asymmetry in retail rates, large deviations from equilibrium mark-ups are faster reduced than small deviations. Overall, conditions for corporate loans are more competitive compared to consumer loans. Demand and savings deposits have, by far, the most rigid prices.     

Credit derivatives and loan pricing

This paper examines the relation between the new markets for credit default swaps (CDS) and banks’ pricing of syndicated loans to US corporates. We find that changes in CDS spreads have a significantly positive coefficient and explain about 25% of subsequent monthly changes in aggregate loan spreads during 2000–2005. Moreover, when compared to traditional explanatory factors, they turn out to be the dominant determinant of loan spreads. In particular, they explain loan rates much better than same rated bonds. This suggests that CDS prices contain, beyond general credit risk, to a substantial extent information relevant for bank lending. We also find that, over time, new information from CDS markets is faster incorporated into loans, but information from other markets is not. Overall, our results indicate that the markets for CDS have gained an important role for banks.     

Institutional ownership composition and accounting conservatism

This study empirically investigates the association between institutional ownership composition and accounting conservatism. Transient (dedicated) institutional investors, holding diversified (concentrated) portfolios with high (low) portfolio turnover, focus on portfolio firms’ short-term (long-term) perspectives and trade heavily (generally do not trade) on current earnings news. Thus, I predict that as transient (dedicated) institutional ownership increases, firms will exhibit a lower (higher) degree of accounting conservatism. Consistent with my predictions, in the context of asymmetric timeliness of earnings, I document that as the level of transient (dedicated) institutional ownership increases, earnings become less (more) asymmetrically timely in recognizing bad news.     

Managerial risk incentives and accounting conservatism

Review of Quantitative Finance and Accounting - We provide empirical evidence of the effect of managerial risk incentives on financial reporting conservatism. We hypothesize that firms use greater...     

Asset specificity and conditional accounting conservatism

Asset specificity, the redeployability of an asset to alternative uses, is a key determinant of an asset's resale value. Asset specificity has a direct impact on a firm's ongoing fair value determination, bankruptcy risk, liquidation value, and abandonment option. We document a significant negative association between asset specificity and conditional conservatism. Further tests reveal that this inverse relation manifests as bad news being less quickly incorporated in earnings as asset specificity increases. We find no difference in the extent to which good news is delayed in earnings for firms conditional on asset specificity. In addition, the documented association is stronger when asset specificity arises from lower within‐industry acquisition activity. The association is also more pronounced for firms that are in less competitive industries, have institutional investors, have limited access to the public debt market, and/or have more unsecured debt. Our findings are noteworthy for regulators and researchers given the recent interest in the determinants of conservatism.     

The effect of borrowers' accounting conservatism on lenders' loan loss provisions: Evidence from China's banking industry

This paper investigates how borrowers' accounting conservatism affects lenders' loan loss provisions in the Chinese banking context. We predict that when borrowers' financial statements are more conservative, lenders receive borrowers' bad news in a timelier manner and set aside more loan loss provisions. The empirical results confirm that borrowers' accounting conservatism is positively associated with lenders' loan loss provisions, as the former affects the latter via its impact on loan classification, and this positive association is more pronounced when information asymmetry is higher. In heterogeneity tests, we find that this positive association is stronger for non-state-owned, listed, and less prudent lenders and also varies across debt contract characteristics. Collectively, the results of this study offer insights into how lenders accrue loan losses when borrowers' financial reporting is more conservative.     

Corporate suppliers and customers and accounting conservatism

We argue that a firm's suppliers and customers prefer it to account more conservatively due to information asymmetry and these stakeholders' asymmetric payoffs with respect to the firm's performance. We predict that a firm meets this demand for accounting conservatism when suppliers or customers have bargaining advantages over it that enable them to dictate terms of trade or whether trade occurs at all. We show that when a firm's suppliers or customers have greater bargaining power, the firm recognizes losses more quickly. Our findings provide insights into how a firm's powerful suppliers and customers are associated with its accounting practices and also support the contracting explanation for accounting conservatism.     

Non-executive ownership and private loan pricing

This paper examines the link between non-executive employee ownership and the terms and pricing of corporate loans. We find that a one-standard-deviation increase in employee stock ownership is associated with 1.67% decrease in loan spreads and one fewer restrictive loan covenant. The negative effect of employee stock ownership on loan spreads remains significant when we use within-firm variation and perform an analysis with instrumental variables based on demographic characteristics to address the concerns of endogeneity. Further analysis reveals that employee stock ownership may affect loan spreads by improving corporate governance, curbing managerial risk-taking, reducing information asymmetry, and improving employee retention. In contrast, we find that employee ownership via stock options is associated with greater loan spreads, perhaps owing to their convex payoff structure. Overall, our results underscore the importance of the level and structure of employee ownership for pricing corporate loans.     

Corporate misreporting and bank loan contracting

This paper is the first to study the effect of financial restatement on bank loan contracting. Compared with loans initiated before restatement, loans initiated after restatement have significantly higher spreads, shorter maturities, higher likelihood of being secured, and more covenant restrictions. The increase in loan spread is significantly larger for fraudulent restating firms than other restating firms. We also find that after restatement, the number of lenders per loan declines and firms pay higher upfront and annual fees. These results are consistent with banks using tighter loan contract terms to overcome risk and information problems arising from financial restatements.     

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.     

CEO overconfidence and bank loan contracting

In this paper, we examine the effect of managerial overconfidence on bank loan spreads. Our theoretical model and empirical results support that firms with highly overconfident CEOs have lower loan spreads and that the reducing effect of these CEOs on the spread is more pronounced when the loan contracts have collateral or covenants. Unlike firms with highly overconfident CEOs, firms with moderately overconfident CEOs do not receive lower loan spreads. We perform various tests to alleviate the concerns about endogeneity, and the results are robust. The results are consistent with the idea that highly overconfident CEOs are more willing to pledge collateral and accept covenants in exchange for a reduction in their loan rate.