12 Financial Accounting 7: Debt market research (debt contracting and credit ratings) (FAR7)
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ItemMandatory Accounting Rules and Private Contract Solutions—Evidence from Lease Accounting( 2022)Abstract: We study the private lending market’s accounting solutions for operating leases and how FASB’s new lease accounting standard (ASC 842) affects them. Contrary to a popular assumption in prior literature, we find that most loan contracts exclude capitalized operating leases from debt and debt-based covenants (like debt-to-earnings ratio covenants), regardless of the accounting standards in place. Where operating leases are counted as debt, their measurements are often tailored to individual transactions. We report that firms with larger operating lease obligations pay no higher or lower interest spread than firms with smaller operating lease obligations, and the new standard’s implementation does not change this pattern. Firms with more intense operating lease obligations are more likely to renegotiate contracts to include/update fixed-GAAP clauses to undo ASC 842’s capitalization requirement. The new standard creates a potential unintended effect: upon losing leases’ off-balance sheet treatment, firms gravitate away from leases to purchases, and the associated (expected) borrowings subject firms to more and tighter debt-based covenants.
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ItemAccess to Credit in Informal Economies: Does Financial Information Matter?( 2022)Traders operating in informal economies, characterized by low economic development and growth, rarely use financial information in their credit allocation decisions. However, using this information could improve the efficiency of lending decisions, thereby increasing access to credit and promoting economic growth. We use a combination of survey questions and a hypothetical choice experiment to study traders’ preferences for financial information in a bazaar economy. Although wholesalers value informal information such as retailers’ community membership and relationship length, they also overwhelmingly value retailers’ sales and profits in making credit decisions. Based on estimates of wholesalers’ willingness to pay for various types of retailer information and retailers’ responses to survey questions, our findings suggest that the perceived lack of reliability of financial information, rather than financial illiteracy, drives the current sparse use of financial information.
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ItemThe Influence of External Legal Counsel on Loan Contract Design and Performance( 2022)We investigate whether external legal counsels (ELCs) affect the design and performance of syndicated loan contracts. Using a dataset of ELCs representing both borrowers and lenders in the U.S. syndicated loan market and fixed effect models, we find that ELCs explain significant variation in loan contract characteristics, including loan spreads, covenants intensity, and covenants strictness. To understand one of the potential channels through which ELCs exert their influence, we explore the role of ELCs acting as transaction cost engineers. We find that connected ELCs, i.e., ELCs advising the lender (borrower) and with a recent working relationship with the borrower (lender), reduce information asymmetries between the two sides of the transaction, thus lowering interest spreads as well as the intensity and the strictness and of loan covenants. Furthermore, we document that ELCs affect future loan performance—loan contracts with ELCs are less likely to be downgraded or experience default.