Lender Exposure and Effort in the Syndicated Loan Market.pdf

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nonnancial borrowers. The relationship between the share retained by the lead and subsequentperformance is tighter in periods of high commercial paper spreads than in periodsof low spreads (columns (4) and (5) of Table 4). This relationship is greater and statisticallysignicant when market liquidity is tight and the lead arranger was also a previouslead, as shown in the last two columns (the effect is -0.0033 standard error 0.0018).These results – together with scattered evidence in the previous section – begin to builda case for the moral hazard view. There were three pieces of evidence discussed in Section5 that were also compatible with the monitoring interpretation. First, the share retained bythe lead was more important for credit lines than for term loans. Credit lines are expectedto require more intensive monitoring (Drucker and Puri, 2009; Su, 2009). Second,banks with a high opportunity cost of holding loans in portfolio (such as capital-constrainedbanks) were not found to syndicate good loans (nor bad loans, for that matter). But capitalconstrainedbanks did hold a smaller share of a loan, and the latter channel had an indirecteffect on the borrower's outcome. Third, lead arrangers were found to keep a smaller portionof the loan when they had been previously engaged as lead arrangers by the borrower.In contrast, they would be expected to retain a larger share under the alternative selectionand signaling view. 216.1 CovenantsIf the lead arranger takes actions to inuence the borrower's outcome, as the results indicate,there is little evidence on how it does so.Loan covenants (terms and conditionsin the loan contract) may be a means by which the lead exerts inuence.Covenants areplausible candidates because they are designed to mitigate agency problems at some pointin the future.There are a number of competing views on the function of covenants and these are wellarticulated in a review by Gorton and Winton (2003). These views are not, however, mutuallyexclusive because different covenants can serve different complementary functions.In the traditional view (Smith and Warner, 1979), covenants protect debtholders by limitingrisk-shifting behavior by the borrower (such as asset-substitution by shareholders) and bycurbing managerial rent-seeking (such as shirking by the management and investment inprivate benet ventures).21 This last point was also raised by Su (2007). He reasoned that if information asymmetry is because ofmoral hazard in monitoring, then a lead that was previously involved with a borrower can form more diffusesyndicates because it monitored the rm and in doing so, learnt about it. If, on the other hand, informationasymmetry is because of private information that the lead has but the participant lenders lack, then the leadarranger would be forced by participants to retain more on future loans.19
The modern view sees covenants in a more dynamic way. Lenders take actions. Covenantsare a mechanism through which an informed lender can inuence the borrower'sbusiness decisions and nancial structure by threatening default and renegotiating. Withinthis view, covenants provide an incentive to the delegated monitor to regularly collect andprocess information about the borrower. In this way, they serve as “tripwires” (Rajan andWinton, 1995). 22This makes a loan's effective maturity contingent on monitoring by thelender. Without monitoring the borrower's condition based on information only availableto the public at a cost, the bank would not be able to take action to show that the covenanthas been violated. Rajan and Winton support this view with legal evidence. Courts do notsupport a lender's claim to enforce a covenant if previous inaction implicitly meant that thecovenant had been waived.The third view – nested within this modern view – is that covenants dene how controlrights are allocated after a covenant has been violated (known as a technical default)(Aghion and Bolton, 1992). Both modern interpretations are about the lender taking actionbut the key operative distinction is in the timing: whether the lender gets control rights expost or whether the lender's power to inuence the borrower is dependent on it monitoringand gathering information in the rst place.There is existing empirical support for all three interpretations. 23For example, covenantprotection has been shown to be increasing in the borrower's growth opportunities andleverage, which are more likely to be associated with risk-shifting behavior by shareholders(Billett et al, 2007).Loans with more stringent covenants result in a higher recoveryrate (upon default) for the lender, also consistent with covenants allaying value reductionactivities by shareholders (Zhang, 2010).A number of papers analyze state-contingenttransfer of control rights to creditors (e.g., Chava and Roberts, 2008; Roberts and Su,2009). The former study nds that a borrower's investment is reduced following a covenantviolation.Besides the anecdotal evidence, Su (2009) provides evidence of activemonitoring to maintain nancing, which is closest to Rajan and Winton (1995).Usingrepeated SEC lings on rms' credit lines and drawn amounts, he shows that lines of credit22 For example, S&P (2006) discuss the exchange of condential information that goes on after the creditagreement has been signed. These include nancial disclosures at frequent intervals, covenant complianceinformation, waiver requests, and nancial projections and plans.23 Moreover, different covenants can serve different purposes. Falling under the traditional view are restrictionson dividend payments, on new debt issuance, on changes in business focus, and on “sweeps” covenantsthat ensure that proceeds from asset sales go to the reduction of debt. Alternatively and consistent withthe modern view, nancial covenants such as net worth and interest coverage, make sure that the borrowerstays nancially sound (or likewise determine the conditions under which control rights are transferred to thedebtholders).20
Page 3 and 4: 1 IntroductionFinancial innovations
Page 5 and 6: ables research design similar to Iv
Page 7 and 8: 2.1 Evidence of Information Asymmet
Page 9 and 10: the borrower. It is also true that
Page 11 and 12: To address this concern, the second
Page 13 and 14: 5 Information Asymmetry and Subsequ
Page 15 and 16: a multivariate specication with an
Page 17 and 18: decision to draw down the line depe
Page 19: hazard, and specically via a dynami
Page 23 and 24: to induce the delegated monitor to
Page 25 and 26: constraints are greater for more le
Page 27 and 28: [16] Focarelli, Dario, Alberto Fran
Page 29 and 30: Table 1. Summary statisticsSyndicat
Page 31 and 32: Table 3. Lead Bank Characteristics
Page 33 and 34: Table 5. Dynamic Tests of Moral Haz
Page 35 and 36: Table 7. The Relationship Between C
Page 37 and 38: Appendix A: Variable Definitions, c
Page 39 and 40: Table A.2. Robustness Checks: Opaci

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