Essays on Banking and Debt Contracting
Butler, Alexander W; Grullon, Gustavo; Weston, James P
Doctor of Philosophy
This dissertation contains three chapters. In the first chapter, I investigate whether restrictive loan covenants disrupt or improve firm operating performance. Using an instrumental variables approach to address the endogenous relationship between covenant strictness and firms' efficiency, I find stricter loan covenants cause an increase in profitability and a reduction in operating cost. Stricter covenants improve performance only in firms with poor governance: those without large shareholder ownership, with weaker shareholder rights, facing softer competition in their product market, or with inside director dominated boards. The evidence is consistent with the view that the design of debt contracts can mitigate agency costs in firms that lack alternative governance mechanisms. The second chapter focuses on the relationships that banks develop with other lenders through syndicated loans, one of the largest sources of external finance for firms. A small number of interconnected banks increasingly dominate the syndicated loan market. In this chapter, I use measures from network analysis to test whether lender interconnectedness benefits borrowers through efficiency gains, or is harmful due to increased market power. Traditional measures of industry concentration are not relevant in the syndicated loan market because lenders share information and resources. Using bank mergers to identify exogenous variation in lenders' interconnectedness, I find that an increase in lender network centrality reduces firms' cost of borrowing. The effects are larger for borrowers with higher levels of information asymmetry, consistent with theories suggesting that facilitating information sharing increases lending efficiency. The third chapter examines whether creditor protection rights affect the structure of corporate debt. Improving legal protection of creditor interests may expand firms' access to debt markets, but also increases creditors' rights to intervene with firm policies. Using variation from legal rulings in Delaware, I find that increasing creditor protection leads to a reduction in senior secured debt and an increase in unsecured bonds, especially for firms close to bankruptcy. Reducing creditors' ability to sue managers for breach of fiduciary duty leads to a large increase in secured debt with more restrictive covenants. The results suggest that legal protection of creditor interests affects firms' choice of debt structure.
Debt contracts; covenants; lenders; interconnectedness; creditor control rights