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.     

The determinants of bank loan recovery rates

Using Moody’s Ultimate Recovery Database, we estimate a model for bank loan recoveries using variables reflecting loan and borrower characteristics, industry and macroeconomic conditions, and several recovery process variables. We find that loan characteristics are more significant determinants of recovery rates than are borrower characteristics prior to default. Industry and macroeconomic conditions are relevant, as are prepackaged bankruptcy arrangements. We examine whether a commonly used proxy for recovery rates, the 30-day post-default trading price of the loan, represents an efficient estimate of actual recoveries and find that such a proxy is biased and inefficient.     

Understanding the rise and decline of the Japanese main bank system: The changing effects of bank rent extraction

This paper shows how main bank rent extraction affects corporate decisions about investment and financing during financial regulatory reform. Our model predicts that limited loanable funds can initially contain main bank controlled overinvestment, even when new equity is available to the firm. Abundant funds facilitate overinvestment to the detriment of firm profitability. A shift of control rights back to the firm due to financial deregulation produces an “equity for upside potential and bank debt for downside risk” bias against the banks. A stock market and real estate boom in Japan made it harder than ever for the banks to diversify risk. The insights from this analysis help explain why Japan’s main bank system was beneficial in the (capital constrained) postwar period but became harmful during the (capital abundant and even bubbly) 1980s, and why the adverse shocks of the post-deregulation 1990s had such severe effects on the banking system.     

Nonlinear dynamics in discretionary accruals: An analysis of bank loan-loss provisions

Several studies have analyzed discretionary accruals to address earnings-smoothing behaviors in the banking industry. We argue that the characteristic link between accruals and earnings may be nonlinear, since both the incentives to manipulate income and the practical way to do so depend partially on the relative size of earnings. Given a sample of 15,268 US banks over the period 1996–2011, the main results in this paper suggest that, depending on the size of earnings, bank managers tend to engage in earnings-decreasing strategies when earnings are negative (“big-bath”), use earnings-increasing strategies when earnings are positive, and use provisions as a smoothing device when earnings are positive and substantial (“cookie-jar” accounting). This evidence, which cannot be explained by the earnings-smoothing hypothesis, is consistent with the compensation theory. Neglecting nonlinear patterns in the econometric modeling of these accruals may lead to misleading conclusions regarding the characteristic strategies used in earnings management.     

Corporate ownership structure and bank loan syndicate structure

Using a novel data set on corporate ownership and control, we show that the divergence between the control rights and cash-flow rights of a borrowing firm's largest ultimate owner has a significant impact on the concentration and composition of the firm's loan syndicate. When the control-ownership divergence is large, lead arrangers form syndicates with structures that facilitate enhanced due diligence and monitoring efforts. These syndicates tend to be relatively concentrated and composed of domestic banks that are geographically close to the borrowing firms and that have lending expertise related to the industries of the borrowers. We also examine factors that influence the relation between ownership structure and syndicate structure, including lead arranger reputation, prior lending relationship, borrowing firm informational opacity, presence of multiple large owners, laws and institutions, and financial crises.     

Asymmetric information effects on loan spreads

This paper estimates the cost arising from information asymmetry between the lead bank and members of the lending syndicate. In a lending syndicate, the lead bank retains only a fraction of the loan but acts as the intermediary between the borrower and the syndicate participants. Theory predicts that asymmetric information will cause participants to demand a higher interest rate and that a large loan ownership by the lead bank should reduce this effect. In equilibrium, however, the asymmetric information premium demanded by participants is offset by the diversification premium demanded by the lead. Using shifts in the idiosyncratic credit risk of the lead bank's loan portfolio as an instrument, I measure the asymmetric information effect of the lead's share on the loan spread and find that it accounts for approximately 4% of the total cost of credit.     

Information asymmetry and self-selection bias in bank loan announcement studies

Event-study driven research has produced a consensus that loans are unique relative to other financial contracts. But these studies assume that small samples of loan announcements adequately represent the loan population. We find that loan announcements are rare and driven by factors such as information asymmetry and perceived materiality. We show that the sample used by Billett, Flannery, and Garfinkel (1995) fails to represent the loan universe and that significant abnormal announcement returns are confined to their smallest firms. Our sample, which better represents the loan population, produces an abnormal return insignificantly different from zero. The findings suggest that self-selection bias affects extant loan announcement research and do not support the views that loans are a special form of finance or that private and public debt differ in significant ways. Were all loans to be announced, the average abnormal return would likely be insignificant.     

TARP funds distribution and bank loan supply

This paper investigates the determinants of the Troubled Asset Relief Program (TARP) funds distribution to banks and the stimulus effect of TARP investments on credit supply in the economy. Using banks’ political and regulatory connections as instruments, this paper finds that TARP investments increased bank loan supply by an annualized rate of 6.36% for banks with below median Tier 1 capital ratios. This increase is found in all major types of loans and can be translated into $404 billion of additional loans for all TARP banks. On average, TARP banks employed about one-third of their TARP capital to support new loans and kept the rest to strengthen their balance sheets. Furthermore, there is little evidence that loans made by TARP banks had lower quality than those by non-TARP banks. In sum, this paper shows a positive stimulus effect of TARP on credit supply during the 2008–2009 financial crisis.     

The impact of corporate social responsibility on the cost of bank loans

This study examines the link between corporate social responsibility (CSR) and bank debt. Our focus on banks exploits their specialized role as delegated monitors of the firm. Using a sample of 3996 loans to US firms, we find that firms with social responsibility concerns pay between 7 and 18 basis points more than firms that are more responsible. Lenders are more sensitive to CSR concerns in the absence of security. We document a mixed reaction to discretionary CSR investments. Low-quality borrowers that engage in discretionary CSR spending face higher loan spreads and shorter maturities, but lenders are indifferent to CSR investments by high-quality borrowers.     

Cross-country determinants of bank income smoothing by managing loan-loss provisions

This paper studies the determinants of income smoothing by management of loan-loss provisions in banks around the world. Using a panel database of 3221 bank-year observations from 40 countries and controlling for unobservable bank effects and for the endogeneity of explanatory variables, we find that bank income smoothing depends on investor protection, disclosure, regulation and supervision, financial structure, and financial development. Results suggest there is less bank income smoothing not only with the strength of investor protection, but also with the extent of accounting disclosure, restrictions on bank activities, and official and private supervision, while there is more income smoothing with market orientation and development of a country’s financial system.     

The impact of bank ownership concentration on impaired loans and capital adequacy

This paper examines the impact of bank ownership concentration on two indicators of bank riskiness, namely banks’ non-performing loans and capital adequacy. Using balance sheet information for around 500 commercial banks from more than 50 countries averaged over 2005–2007, we find that concentrated ownership (proxied by different levels of shareholding) significantly reduces a bank’s non-performing loans ratio, conditional on supervisory control and shareholders protection rights. Furthermore, ownership concentration affects the capital adequacy ratio positively conditional on shareholder protection. At low levels of shareholder protection rights and supervisory control, ownership concentration reduces bank riskiness.     

Bank audit practices and loan loss provisioning

I empirically examine the evolution of loan loss accounting across banks that differ categorically by external auditing practice. Using a partial adjustment model, and a sample of 75,505 observations on affiliated banks, 1995–2009, I find evidence of convergence across audit categories in target ratios of provisions for loan losses to nonaccrual loans. This is consistent with a standardized method of accounting for “impaired” loans. I observe less convergence, on the other hand, in target ratios of provisions for loan losses to loans, which appears to accommodate a role for managerial discretion.     

How bank capital buffers vary across countries: The influence of cost of deposits,market power and bank regulation

This paper analyzes the bank and country determinants of capital buffers using a panel data of 1337 banks in 70 countries between 1992 and 2002. After controlling for adjustment costs and the endogeneity of explanatory variables, the results show that capital buffers are positively related to the cost of deposits and bank market power, although the relations vary across countries depending on regulation, supervision, and institutions. Their impact is the result of two generally opposing effects: restrictions on bank activities and official supervision reduce the incentives to hold capital buffers by weakening market discipline, but at the same time they promote higher capital buffers by increasing market power. Institutional quality has the two opposite effects. Better accounting disclosure and less generous deposit insurance, however, have a clear positive effect on capital buffers by both strengthening market discipline and making charter value better able to reduce risk-taking incentives.     

The effects of reform on China’s bank structure and performance

This paper investigates the relationship between market structure and performance in China’s banking system from 1985 to 2002, a period when this sector was subject to gradual but notable reform. Using panel data estimation techniques, both the market-power and efficient-structure hypotheses are tested. In addition, the model is extended to consider issues such as the impact of bank size/ownership and whether the big four banks enjoy a “quiet life”. On average, X-efficiency declined significantly and most banks were operating below scale efficient levels. Estimation of the structure–performance models lends some support to the relative market-power hypothesis in the early period. The reforms had little impact on the structure of China’s banking sector, though the “joint stock” banks became relatively more X-efficient. There was no evidence to support the quiet-life hypothesis, probably because strict interest rate controls prevented the state banks from earning monopoly profits. Thus the ongoing liberalisation of interest rates should be accompanied by reduced concentration. Overall, to improve competitive structure, new policies should be directed at encouraging market entry and increasing the market share of the most efficient banks.     

Impact of FDICIA internal controls on bank risk taking

The Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 was designed, among other things, to introduce risk-based deposit insurance, increase capital requirements, and improve banks’ internal controls. Of particular interest in this study are the requirements for annual audit and reporting of management’s and auditor’s assessment of the effectiveness of internal control for banks with $500 million or more in total assets (raised to $1 billion in 2005). We study the impact of these requirements on banks’ risk-taking behavior prior to the recent financial crisis and the consequent implications for bank failure and financial trouble during the crisis period. Using a sample of 1138 banks, we provide evidence that banks required to comply with the FDICIA internal control requirements have lower risk taking in the pre-crisis period. Specifically, the volatility of net interest margin, the volatility of earnings, and Z score show less risk-taking behavior. Furthermore, these banks are less likely to experience failure and financial trouble during the crisis period.     

A comprehensive analysis of the effects of risk measures on bank efficiency: Evidence from emerging Asian countries

This study investigates the role of risk in determining the cost efficiency of international banks in eight emerging Asian countries. Researchers of this paper consider three distinct risk aspects under a total of eight risk measures: credit risk, operational risk, and market risk. We apply a heteroscedastic stochastic frontier model to estimate bank cost efficiency in our analysis. Additionally, this study analyzes the marginal effects of all risk measures on the inefficiency effect in order to explore a more detailed relationship between risks and efficiency. The empirical results indicate that the risk measures represent significant effects on both the level and variability of bank efficiency. We also find that these effects vary across countries and over time.     

The influence of loan officers on loan contract design and performance

We investigate the extent to which loan officers generate independent, individual effects on the design and performance of syndicated loans. We construct a large database containing the identities of loan officers involved in structuring syndicated loan deals, allowing us to systematically disentangle borrower, bank, and loan officer fixed effects. We find that loan officers have significant influence on interest spreads, loan covenant design, and loan performance. Inclusion of borrower fixed effects increases our power to rule out the alternative that loan officer fixed effects reflect the matching of officerds to borrowers based on time-invariant borrower characteristics. We document heterogeneity in loan officers’ influence across loan contract terms, with loan officers exerting stronger influence over covenant package design than over interest spreads, but marginal influence on loan maturity. Lead officers have greater influence than participant officers over covenant package design and loan performance, but less robust differential influence on interest spreads.     

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.