Two Essays on Lending and Monitoring

In this dissertation, I first contribute to our understanding of why optimal loan contracts include covenants and how trade-offs between monitoring costs, hold-up costs, and information asymmetries determine the level of covenant protection given to creditors. Second, I investigate if and how monitoring choices are affected by corporate loan securitization. Finance theory offers two channels through which covenants become part of an optimal debt contract. One theory argues that covenants make the lender's payoff contingent on monitoring the borrower and thereby create monitoring incentives. However, having one lender that monitors can be costly since that lender may be able to extract rents when the borrower violates a covenant. The second theory considers information asymmetries between borrowers and lenders and predicts that creditors should protect themselves by demanding strong covenants when they do not know the borrower well. I test these theories comprehensively using a novel identification approach based on lending relationships. Using a large dataset of syndicated loans originated in the US over the period from 1995-2008, I find that borrowers trade off monitoring benefits with covenant-created hold-up costs, such that the effect of lending relationship intensity on the number of covenants included in a loan follows an inverted U shape. The curvature of the inverted U depends on the borrower's bargaining power and the extent to which covenant benefits accrue exclusively to the originating bank. Consistent with covenant tightness addressing information asymmetry concerns, tightness is relaxed over the course of a relationship. In my second essay, I assess the effect of corporate loan securitization on lenders' monitoring efforts. In a corporate loan securitization, fractions of syndicated loans are bundled into a collateralized loan obligation (CLO), against which several tranches of securities are issued to the ultimate investors. For these investors the benefits of monitoring the underlying loans will be small relative to the costs of doing so. To the extent that the originating bank can offload credit risk to the CLO investors, the bank's incentive to screen and monitor borrowers may be limited. However, CLO investors may recognize this problem and demand stronger contractual protection. Using a sample of securitized and unsecuritized loans that were originated between January 2002 and June 2007, I find that securitization does not seem to affect the number or tightness of a loan's financial covenants. Securitized loans have longer maturities, but have more non-financial covenants and are more likely to require collateral. There is no consistent evidence that increases in institutional lenders' demand for loans reduce the strictness of loan contracts. Borrowers of securitized loans are no more likely to violate a covenant than other borrowers. Shareholder payouts decline more strongly for violators with securitized loans, while sanctions on debt capacity and interest rates are similar for both groups. Overall, the results suggest that the unique setup of the syndicated loan market prevents many of the problems that can occur in residential mortgage securitizations.

Name thesis:degree_name

Doctor of Philosophy

Level thesis:degree_level

doctoral

Discipline thesis:degree_discipline

Business Administration

Grantor dc:publisher

The Ohio State University

Year dc:date

2013

Author dc:creator

• Prilmeier, Robert

Contributors dc:contributor

• Stulz, René

• Finance
• Banking
• covenants
• monitoring incentives
• syndicated loans
• lending relationships
• securitization

Statement dc:rights

• unrestricted
• This thesis or dissertation is protected by copyright: all rights reserved. It may not be copied or redistributed beyond the terms of applicable copyright laws.

Language dc:language

English

Repository record dc:identifier

http://rave.ohiolink.edu/etdc/view?acc_num=osu1366124597

OAI identifier oai:identifier

oai:etd.ohiolink.edu:osu1366124597