16 Financial: Debt and derivative instruments/Creditor protection/Risk management
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ItemThe Bond Market Benefits of Corporate Social Capital( 2018-08-30)We investigate whether a firm’s social capital, and the trust that it engenders, are viewed favorably by bondholders. Using firms’ corporate social responsibility (CSR) activities to proxy for social capital, we find no relation between CSR and bond spreads over the period 2005-2013. However, during the 2008-2009 financial crisis, which represents a shock to trust and default risk, high-CSR firms benefited from lower bond spreads. These effects are stronger for firms with higher expected agency costs of debt. During the crisis, high-CSR firms were also able to raise more debt at lower spreads, better credit ratings, and longer maturities.
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ItemDo Banks Care about CEO’s Influence on Director Appointment?( 2018-08-29)We study the effect of CEO’s influence in the board of directors’ appointment on bank loans. Theory offers two competing hypotheses: the “management hegemony” and the “informative advising” hypotheses. Using a sample of bank loans from 1996 to 2012, we document a positive relation between board co-option and loan spreads, consistent with more co-opted boards having less effective monitoring. Our cross-sectional tests reveal that the effect of board co-option on the cost of bank loans is more pronounced for firms that have longer CEO tenures and firms that have CEO at the same time being the board chairperson. To further identify causality, we exploit the change in the listing requirement by NASDAQ and NYSE. We find that loan spreads are significantly higher when the board co-option measure increases due to the new listing requirement in NASDAQ and NYSE. We also find that more co-opted boards are associated with higher likelihood of collateral requirement, higher number of covenants and financial covenants, and higher covenants intensity. We further find that more co-opted boards are associated with worse credit ratings. Our findings are consistent with the “management hegemony” hypothesis that bank loans are more costly when internal monitoring is less effective in co-opted boards.
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ItemCorporate Derivatives as a Manager-Specific Investment( 2018-08-29)This study examines one manager-specific investment, the use of derivatives, and the corresponding market for corporate control. We find firms with large derivatives positions or increases in their unrealized derivatives gains are associated with a significantly lower likelihood of being the target of an acquisition. We further find firms with greater magnitude of derivatives are associated with weaker boards. Consistent with derivatives being used by managers to protect themselves from disciplinary forces, we find the absolute size of firms’ unrealized derivatives value is negatively associated with firm value. Finally, firms with decreasing (increasing) idiosyncratic risk as well as increasing (decreasing) absolute value of changes in derivatives realized gains and losses, exhibit a decreasing (increasing) likelihood of takeovers. In summary, the findings are consistent with derivatives being an example of a manager-specific investment (Shleifer and Vishny (1989)) that is successful at entrenching management.
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ItemThe Effect of Political Polarization on State Government Bonds( 2018-08-28)We examine the effect of political polarization within state legislatures on state bond yields. Defined as the ideological distance between the Democratic and Republican members of the state legislative chambers, political polarization captures the willingness of legislators to seek bipartisan compromises. We expect that states with high polarization are riskier because they are more likely to experience gridlock, which negatively affects economic development and commitment to debt service. We find that the bonds issued by highly polarized states exhibit significantly higher yields at issuance compared to the states with lower levels of political polarization. A one standard deviation increase in polarization increases bond yields by 14.7 basis points and total interest expense by $4.3 million for an average bond issue. Furthermore, we find that the effect of polarization on bond yields is greater for general obligation bonds.
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ItemLending Corruption and Bank Loan Contracting: Cross-Country Evidence( 2018-08-22)Lending corruption is an important agency problem for banks. Using data from the World Bank Business Environmental Survey, we find that in countries with more corruption, banks give more favorable loan terms to borrowers. This relation is stronger when firms are under more financing constraints, consistent with corruption being important to obtaining favorable loan terms when the supply of debt capital is tighter. In line with the expectation that monitoring constrains agency problems, this relation is weaker in countries with higher foreign ownership of banks or where Protestantism is the primary religion. In the syndicated loan market, participant banks are inclined to lend less in countries where lending corruption is more prevalent. Firms in countries with greater corruption prefer private bank debt over public bonds and are more leveraged. Banks in countries with more lending corruption have poor loan quality, worse earnings performance, and are more susceptible to trouble during a financial crisis. Overall, our findings suggest that corruption greases the wheels for borrowers but is detrimental to bank shareholders.
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ItemFinancial Statement Complexity and Bank Lending( 2018-08-01)Recent studies and anecdotal evidence suggest that investors struggle to process complex financial reports. Existing theory and evidence demonstrate that banks not only have unique advantages in acquiring information, relative to equity and public debt investors, but also can impose contractual terms to mitigate information frictions. We investigate whether financial statement complexity is associated with firms' reliance on bank financing and with the terms of bank loans (i.e., the amount and rate of the loan, along with covenants and collateral). We focus on two dimensions of complexity that capture the volume and presentation of financial information: 10-K length and readability. We find that complexity is positively associated both with firms' reliance on bank financing and with banks increasing their level of screening, rationing their credit supply, and imposing tighter covenants. Our results suggest that banks continue to play their role as informed capital providers in a changing economy, characterized by growing financial statement complexity and innovations in banks' business models.
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ItemThe Role of CDS Trading in the Commercialization of New Lending Relationships( 2018-07-27)We investigate how the development of the credit default swap (CDS) market affects lenders’ incentives to initiate new lending relationships. We predict that CDSs reduce the adverse selection that non-relationship lenders face when competing for loans, by allowing those lenders to hedge loan exposure and by the revelation of private information through CDS spreads. We find that, following CDS initiation on a borrower’s debt, non-relationship lead arrangers are more likely to originate its loans and non-relationship participants are more likely to join loan syndicates. We also show that lead arrangers that initiate lending relationships following CDS initiation focus more on commercial aspects of lending relationship. These lead arrangers are more likely to pursue new borrowers with high cross-selling potential, which are expected to generate substantial fee business. Further, non-relationship lenders have lower incentives for costly borrower monitoring, as reflected in weaker control rights and in the lower loan share they retain. Relative to relationship lenders, non-relationship lenders are likely to be more distant from borrowers, foreign, and less reputable once CDSs become available, emphasizing their lower monitoring efficiency.