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)
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 (forthcoming at 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.
Originate-to-Distribute Lending Relationships and Market Making in the Secondary Loan Market (revising for resubmission to Journal of Accounting Research, dissertation titled "Origination Lenders as Market Makers in the Secondary Loan Market" )
This paper investigates why lenders that originate loans (i.e., origination lenders) commonly make markets for the loans that they sell on the secondary market. Using loan-level market data, I find that origination lenders with extensive borrower relationships and higher reputational capital at stake are more likely to participate as market makers. Further, I demonstrate that greater participation of origination lenders as market makers, relative to other market makers, is associated with lower trading costs for their borrowers' loans traded in the secondary market. The reduction in trading costs is most pronounced during conditions of low liquidity, such as when there are few market makers, when loans are further past their origination date and during market-wide liquidity shocks. Lenders benefit from active participation as market makers by maintaining strong subsequent lending relationships with borrowers. Collectively, this evidence is consistent with origination lenders providing an important source of liquidity for their borrowers’ loans traded in the secondary market and inconsistent with moral hazard in originate-to-distribute commercial lending markets.
The Consequences of Fund-level Liquidity Requirements with Indraneel Chakraborty, Elia Ferracuti and John Heater (revising for resubmission to Journal of Financial Economics)
We investigate the effects that mutual fund liquidity requirements have on fragility. Starting in 2018, SEC Rule 22e-4 restricted ownership of illiquid securities in funds. As expected, post-rule, funds hold more liquid securities. Firms issuing illiquid securities face higher costs due to a smaller investor pool. However, higher liquidity does not ameliorate adverse shocks. Facing outflows, funds maintain cash levels and sell illiquid securities. This is because liquidity requirements are not sufficiently countercyclical: funds must maintain cash even when they should use it to mitigate flow pressures. Hence, outflows force funds to sell more illiquid securities post-rule change, unintentionally increasing fragility.
Lender Learning and the Public Equity Market (previously circulated as "Lender Learning") with Emmanuel De George, John Donovan and Regina Wittenberg-Moerman (Under review)
We examine whether private lenders learn from the equity market. We conjecture that lenders can learn from stock prices new information about firms’ fundamentals and growth opportunities (prospects channel) as well as information about managers’ incentives to take risky actions that may be detrimental to the value of debt claims (incentives channel). Exploiting the mergers and acquisitions (M&A) setting, we find a V-shaped relation between M&A announcement returns and the interest spread on loans issued following M&As. We further show that the association between announcement returns and the interest spread is more pronounced when managers’ risk-taking incentives are likely to be more acute. These findings suggest that lenders learn from stock prices in assessing borrowers’ creditworthiness and that this learning works, at least partially, through the incentives channel. Our evidence highlights a novel channel through which firm stakeholders with incentives misaligned with those of stockholders can learn from stock returns.
Odd Lots & Optics: Retail Investors and Execution Quality Disclosures with Charles Downing, Bradford (Levy) Lynch and Eric So
We study the 2015 introduction of a disclosure program directed toward retail investors, which focused on execution quality of trades under 100 shares, known as odd lots. We show the percentage of odd lot orders receiving price improvement from market makers jumped discontinuously at the outset of the program. This jump was driven by trivially small price improvements 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 to retail investors via the disclosure program. Price improvement was reallocated toward smaller-value trades and trades in large-cap firms, where it was less costly for market makers to provide small amounts of price improvement. Together, our evidence suggests market makers tailored their disclosures to retail investors and aligned their operations to convey strong execution quality, without substantively improving actual trade execution.