Publications and Accepted Manuscripts
Financial Statement Complexity and Bank Lending with Indraneel Chakraborty, Andy Leone, and Miguel Minutti-Meza (The Accounting Review)
Recent evidence suggests that investors struggle to process complex financial disclosures. Relative to equity and public debt investors, banks have unique advantages in acquiring information and can impose contractual terms to mitigate information frictions. We investigate whether financial statement complexity is associated with firms' reliance on bank financing and the terms of bank loans. We focus on two aspects of complexity, the length of financial reports and the complexity of financial reporting rules. We document that both aspects of complexity are positively associated with firms' reliance on bank financing (i.e., level of debt and new financing). This result is consistent with banks' superior information processing capabilities. Next, we document that banks ameliorate information frictions using loan contractual terms that depend on the source of complexity. Overall, banks are an attractive source of financing for firms with complex disclosures, but banks also increase screening and monitoring for relatively complex borrowers.
Contracting in the Dark: The Rise of Public-Side Lenders in the Syndicated Loan Market with Hami Amiraslani, John Donovan and Regina Wittenberg-Moerman (Journal of Accounting and Economics)
SSRN / Journal of Accounting and Economics
We document a novel trend in syndicated lending where some participants voluntarily waive their rights to borrowers’ private information. We posit that “public-side” lending emerged to facilitate broad lender participation in the syndicated loan market by mitigating concerns about the leakage of borrowers’ private information into public securities markets. In line with this proposition, we find that public-side lending facilitates the loan market participation of lenders for which maintaining robust information barriers is particularly costly. Furthermore, while public-side lending increases within-syndicate information asymmetry, our findings indicate that it does not materially increase interest spreads and is associated with lower coordination costs among syndicate participants. Collectively, we document how debt contracting practices evolved to address frictions associated with the protection of borrowers’ private information and the related changes in loan contracting equilibria.
Does Recognition versus Disclosure Affect Debt Contracting? Evidence from SFAS 158 with John Donovan and Andrew McMartin (The Accounting Review)
We study how recognition versus disclosure affects pricing and control allocation in debt contracting. We examine whether loan spreads and the use of covenants changed around SFAS 158 adoption, which required recognition of previously disclosed pension liabilities. We find that pension underfunding is positively associated with loan spreads and negatively associated with the use of covenants prior to the adoption of SFAS 158. This is consistent with lenders viewing disclosed pension underfunding as insufficiently reliable for inclusion in covenants and instead pricing the risk associated with underfunding. Post-SFAS 158, pension underfunding is associated with lower spreads and a higher likelihood of using covenants relative to the pre-period. We find no change in the use of covenants unaffected by the accounting standard change or credit risk associated with underfunding post-SFAS 158. Collectively, the evidence is most consistent with recognition improving the reliability of accounting information for control allocation in debt contracting.
Syndicated Lending Relationships, Information Asymmetry and Market Making in the Secondary Loan Market solo-authored (Accepted, Journal of Accounting Research, dissertation titled "Origination Lenders as Market Makers in the Secondary Loan Market" )
This paper investigates why commercial lenders make markets for the loans that they sell on the secondary market. Using loan-level data, I find that origination lenders with extensive borrower relationships and more reputational capital at stake are more likely to serve as market makers. Greater participation of origination lenders as market makers is associated with lower trading costs for their borrowers' loans. This association remains even in conditions where origination lenders could exploit their information advantage for market making profits. Lenders benefit from being market makers by maintaining strong subsequent lending relationships with their borrowers. Collectively, this evidence is consistent with origination lenders' participation in the secondary market being motivated by reducing trading frictions rather than market making profits.
Working Papers
Lender Learning from the Equity Market: Evidence from M&A Announcements (previously circulated as "Lender Learning") with Emmanuel De George, John Donovan and Regina Wittenberg-Moerman (under second round review at The Accounting Review)
We examine whether private lenders learn from the equity market by examining the pricing of loans issued following mergers and acquisitions (M&As). We document a V-shaped relation between M&A announcement returns and loan interest spreads, indicating that borrowing costs are increasing with both negative and positive announcement returns. We further show that absolute M&A announcement returns are associated with the increase in managerial risk taking and idiosyncratic risk following the M&As, suggesting that lenders learn regarding managers’ incentives to engage in risky actions in response to market feedback. Consistent with this interpretation, the relationship between absolute M&A announcement returns and loan spreads is stronger when managers have greater incentives to undertake risky actions, and weaker in the presence of covenants that restrict these actions. Overall, our findings shed light on how lenders incorporate information from stock prices into their credit risk assessments.
Odd Lots & Optics: Manipulation in Response to Scrutiny with Charles Downing, Bradford (Levy) Lynch and Eric So (revising for resubmission to Journal of Accounting Research)
We study the 2015 introduction of a voluntary disclosure program that focused on the execution quality of equity trades under 100 shares, known as odd lots. The disclosure program was enacted during a period of increased regulatory and media scrutiny of how market makers fulfilled odd lot orders. We show the percentage of odd lot orders that receive price improvement from market makers jumped discontinuously at the outset of the program. This jump was driven by trivially small price improvement given to a larger fraction of orders, and an offsetting reduction in larger price improvement for a small handful of orders. These changes resulted in no material difference in overall execution quality but allowed market makers and brokers to tout high execution quality statistics via their disclosures. Together, our evidence suggests that public scrutiny creates incentives for firms to use mutually reinforcing operational and disclosure changes to manipulate public sentiment.
How Does Recognition of Forward-Looking Estimates Affect Learning About the Macroeconomy? Evidence from CECL with Oliver Binz and Ally Lin
We use the adoption of current expected credit loss reporting for banks as a setting to examine how recognition of managers’ forward-looking estimates affects their learning from stock prices. We posit that recognition of banks’ expected credit losses can reduce managerial learning in two ways. First, managers are forced to invest in information systems that allow them to generate decision-useful information and to rely less on alternative sources, such as stock price. Second, the disclosure of expected credit losses reduces incentives for investors to privately collect and trade based on this information, thereby reducing the informativeness of stock prices for banks’ lending decisions. We find robust evidence that bank managers learn from stock prices under the incurred loss model and that this learning is attenuated under the expected credit loss model. The results vary with banks’ information advantage over equity market participants and are robust to alternative treatment and control groups and measurement approaches. We present evidence that investors incorporate less macroeconomic information in banks’ stock prices and that the reduction in learning hurts banks’ lending efficiency.
Non-Fundamental Loan Renegotiations with AJ Chen, Regina Wittenberg-Moerman and Tiange Ye
We examine whether non-fundamental improvements in secondary market trading conditions lead to renegotiations of syndicated loans. Exploiting a regression discontinuity design around the LSTA100 index reconstitution, we find that loans included in the index are five times more likely to receive interest-rate-reducing amendments relative to comparable loans just below the threshold. Utilizing the within-loan-package interest rate variation, we confirm that these renegotiations are not driven by borrowers’ fundamentals. The threat of refinancing likely drives this effect, as our findings are more pronounced when institutional credit supply is higher and when loans are not subject to call protections.
The Consequences of Fund-level Liquidity Requirements with Indraneel Chakraborty, Elia Ferracuti and John Heater
We investigate the effects of mandatory mutual fund liquidity requirements on fund fragility. After the implementation of SEC Rule 22e-4, as required, bond mutual funds hold more liquid securities. However, we find that additional liquidity does not ameliorate fragility. Post-rule, funds with illiquid securities face greater outflows conditional on past underperformance, and fund exits increase. At the holdings level, funds exhibit a higher likelihood of selling illiquid securities post-rule. In turn, such sales increase fund underperformance, thus completing the vicious cycle of fragility. These results are consistent with the theory that fund-level liquidity does not necessarily reduce fund-run incentives.
Banking on Disagreement: Heterogeneous Credit Risk Assessments in Syndicated Lending with Anya Kleymenova and Florin Vasvari
Using confidential bank supervisory data, we measure lender disagreement about private and public companies' credit risk by capturing the variation in the probability of default (PD) estimates reported by syndicate banks to the Federal Reserve Board. We find that bank disagreement is higher for private and more leveraged borrowers, as well as when syndicates are large, but lower for larger and more profitable borrowers. We then document that bank disagreement leads to higher interest rates, a result that is robust to borrower- and loan-specific controls related to credit risk. In contrast, greater bank disagreement does not appear to affect other loan terms, such as the number of covenants or the presence of loan performance pricing features. This is consistent with evidence that members of loan syndicates primarily focus on interest rate negotiations. We further investigate lender behavior post-loan issuance and find that banks most pessimistic about a borrower's prospects, relative to other syndicate members, are more likely to exit the syndicate. We also find that loan amendment probability is increasing in the amount of ex ante disagreement. Collectively, our analysis provides novel evidence on the consequences of within-syndicate information frictions.
Tax Shields Under Siege: The Effect of Limiting Debt-Related Tax Incentives on Commercial Lending Terms with Ed Maydew and Zirui Song
This paper examines how tax policy affects syndicated loan terms. Using the Tax Cuts and Jobs Act (TCJA) of 2017 as a natural experiment, we analyze changes in loan terms for firms facing higher after-tax borrowing costs due to limits on interest deductibility. We find that borrowers most likely to face limited interest deductibility receive lower interest rates post-TCJA. The rate reduction is approximately 42% of the estimated increase in the after-tax cost of debt for these borrowers post-TCJA. Importantly, we observe no changes in non-price terms such as covenants, maturities, or collateral requirements. Together, the results suggest that lenders bear a portion of the incidence of tax burdens imposed on borrowers, rather than offsetting reduced rates through stricter loan terms. We also find no evidence of changes in the creditworthiness of firms with limited interested deductibility post-TCJA, suggesting that the change in loan spreads is not attributable to changes in borrower fundamentals. Our findings demonstrate that lenders bear a portion of borrowers' tax burdens, suggesting a novel channel by which tax policy affects corporate financing decisions and credit markets.
Book Chapters
Chapter 16: The Role of Financial Reporting in Debt Markets (with Regina Wittenberg-Moerman (forthcoming in Handbook on the Financial Reporting Environment)