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Relationship Lending and Firms’ Leverage: Empirical Evidence in Europe
Abstract
Using a novel measure of relationship lending based on the kind of information banks use to assess borrowers, we investigate the role of relationship lending in firms’ capital structure. Using a unique dataset of European manufacturing firms, we measure relationship lending based on three dimensions (closeness, soft information, exclusivity) and relate them to firms’ leverage. Overall our results support the hypothesis that supply factors matter. We find that the actual use of soft information increases leverage and only firms without soft information-intensive relationships increase their leverage through multiple relationships. However, the effect of relationship lending on leverage varies across countries.
... The closer relationship between SMEs and its borrower also decreases the amount of collateral (Ono & Uesugi, 2009) and the rate of interest and credit rationing that banks ask lenders (Lehmann & Neuberger, 2001). Thus, SMEs have closer communication with banks gain easier credit access conditions, and become more likely to access to credit (Moro et al., 2015;Guida, & Sabato, 2017). In this regard, another hypothesis might be created as follows: ...
... Regarding the closeness of communication and gaining bank loans, this paper also finds similar results with the studies of Moro et al. (2015) and Guida and Sabato (2017) since these scholars also substantiate the positive relationship among those variables. Moreover, the positive association between house bank status and credit access is also vindicated by this paper as other studies do (Petersen & Rajan, 1994;Cotugno et al., 2013). ...
Since many SMEs (small and medium-sized enterprises) lack internal resources, they usually look for external credits that banks are the main providers of. However, most of those businesses’ main concern is to gain credit access since these businesses are not very efficient when minimizing information asymmetries between them and their lenders. Thus, relationship lending that includes close interactions, long-term relationships, and, close ties between SMEs and banks might reduce information asymmetries and might provide easier credit access conditions for SMEs. In this regard, this research aims to investigate the positive association between the length of the relationship, the closeness of communication, the house bank status, and access to bank credit. In line with this selected purpose, the researcher created an online questionnaire and collected data from 479 SMEs operating in Turkey. To examine the specified relationships, the researcher performed Binary Logistic Regression analyses. The results confirm the positive relationships between the variables of relationship lending and access to finance. Therefore, SMEs focusing on socializing and networking activities with banks might receive advantages to gain easier credit access conditions. The reasons for these results might be related to cultural, and executive-firm-specific characteristics, including the structure of society, the sectoral experiences, and the length of doing business, respectively.
... As outlined by [13], Loan conditions include loan cost, a guarantee, and payback schedules. Collateral, which provides a borrower security to a lender, ensures loan repayment. ...
We examine the interplay among commercial bank loan terms, financial literacy, and formal loan accessibility for micro, small and medium enterprises (MSMEs). Despite recent strides in integrating MSMEs into commercial bank portfolios via micro-lending initiatives, persistent challenges hinder their access to formal credit. Drawing from empirical data and existing literature, this study explores the nuanced impacts of loan terms and financial literacy on SMEs’ ability to secure formal loans. Addressing gaps in prior research, we concurrently analyse borrower characteristics and credit regulations’ influence on formal loan accessibility.
... The analysis of FRs is also used to calculate the default risk of firms, which is a fundamental parameter in estimating corporate rating (CR). CRs are methodologies aimed at determining, on the basis of probabilistic methods, the creditworthiness of firms [133][134][135][136]. The application of credit scoring has become extensive with interbank agreements called Basel 2 and Basel 3, imposing the need to use rating systems [137][138][139][140][141][142] also to quantify the price of the money lent, so-called loan pricing [143]. ...
Food geographical indications (GIs) protected by the European Union collective protection mark (CPM) have been the subject of a growing interest. Several research has analyzed the economic, social and environmental role of CPM, which require Production Specifications (PS), imposing constraints to food production, with side effects on performance and corporate strategy.
The research has the aim to analyze, through financial ratios (FRs), the performance of firms in the PDO Parma ham (PrH_PDO) sector; PrH_PDO is the third geographical indication (GI) in Italy among those protected by CPM of the European Union (PDO, PGI, TSG). The research considers, for firms associated with the PrH_PDO Consortium, a series of 10-year annual report, 739 observations, divided into two groups, first of 103 of 11 firms that sell only PrH_PDO and second of 636 of 78 firms that sell not only PrH_PDO. This categorization allows us to highlight and compare the effects of adopting PS in terms of FRs, credit scoring and firms’ strategy.
Research highlights that PrH_PDO_Only firms perform slightly better, with less variable results. Research shows that the PS of Prosciutto di Parma PDO, determines reduction in turnover (T) and a longer duration of the INV_DAYS and, consequently, of the conversion cycle (CCC_DAYS). Research highlights that PrH_PDO_Only firms have a strategy based on higher margins (ROS) which compensates low T; research highlights that credit risk (EM-Score) is higher for PrH_PDO_Only firms.
The research can be replicated in other GI sectors, where there are few studies that have compared firms that produce only GIs and firms that produce not only GIs. The research can be useful to operators in the sector, to financial intermediaries and to policy makers. Lines of applied action may include development of financial instruments to assist maturation period and establishment to assess creditworthiness, tailored to PrH_PDO firms’ characteristics.
... To evaluate financial sustainability, it is necessary to calculate that the return on invested capital (ROA) is higher than the cost of debt [66,67], even in the case of agri-food companies [68,69]. The cost of financial debt is manifested through the payment of interest to credit institutions plus the commissions on the credit lines granted and the costs for services. ...
Agri-food companies ensure food needs of consumers and play a role in protecting health, environment and local territories. For this reason, food and drinks protected by geographical collective marks products (PDO, PGI, TSG)are protected by the European Union. Research investigates Parma PDO Ham sector; in terms of turnover, it is the third Italian production with a protected mark and the first in meat processing. Parma PDO Ham requires aging of at least 14 months according to production specification; this requires significant investments in fixed capital and working capital. The research aims to analyze the financial performance of companies in the sector, dividing companies by size class by quartile. The sample considers all the 140 member firms of the Consortium and, of these, annual account statement data of 101 companies were analyzed, over a 10-year series, for 840 observations. Observations were divided into turnover quartiles; analysis shows that larger companies, in the fourth quartile (Q4), implement a business strategy of higher capital turnover (T), lower inventory turnover (INV_DAYS)and then they achieve better profitability performances (ROE, ROA, Π). Firms Q2 have higher duration of in-ventory cycle (INV_DAYS) with an increase in the cost not compensated by adequate profit margins, and thus we observe the greatest number of cases of Π < 0 (66). Performances of Q3 are better than Q2, both as regard generation of Π and for other FRs. Firms’ Q1 contains debt, possibly due to financial constraints and difficult access to credit. Research can be useful for operators in the sector to highlight the advantages of large enterprises and difficulties of SMEs; policy makers can apply the research to support SMEs in accessing credit. Research can be replicated, particularly in typical product firms’ analysis and in the agri-food sectors where there are com-panies of different size classes
... Empirical research on capital structure determinants concentrates on developed economies and reports mixed results (Drobetz et al., 2013;Guida & Sabato, 2017;Garcia-Rodriguez & Jegers, 2017;Li & Islam, 2019;Li & Singal, 2019;Macnamara, 2019;Michaelas et al., 1999;Moradi & Paulet, 2019). Michaelas et al. (1999) examined the capital structure of small and medium-sized enterprises in the United Kingdom. ...
This research addresses the effects of firm-specific factors on the formation of capital structure in the case of the Chinese technology sector. Also, it aims to shed light on whether the key drivers of capital structure in China are different from those in western countries. To this aim, we analyzed the annual balanced panel data of 460 companies for the period 2007–2017 by means of the structural equation modeling approach. Empirical findings demonstrated that size, financial cost, liquidity, tangibility, profitability, and nondebt tax shields have a significant impact on the leverage structure of Chinese technology firms. Obtained results provide evidence of partial similarities between western countries and China in the determinants of capital structure. Besides, we detected that both trade-off and pecking order theories partially explain the leverage structure decisions of firms in the Chinese technology sector.Key wordsCapital structureTechnology sectorStructural equation modelingChina
... Also, MSEs borrowers reported as an important factor for the willingness of bank to lend, the provision by MSEs of some kind of collateral such as the mortgage. In addition, the survey responses along with empirical evidence indicated that MSEs have cooperation with few banks and tend to concentrate their borrowing to a single bank for many years (Guida and Sabato, 2017). Indeed, these features are reflected in the nature of our sample. ...
... Also, MSEs borrowers reported as an important factor for the willingness of bank to lend, the provision by MSEs of some kind of collateral such as the mortgage. In addition, the survey responses along with empirical evidence indicated that MSEs have cooperation with few banks and tend to concentrate their borrowing to a single bank for many years (Guida and Sabato, 2017). Indeed, these features are reflected in the nature of our sample. ...
... In light of the theoretical background, a large number of empirical studies investigating the determinants of capital structure, which have been sorted under two main theories; that is the pecking order and trade-off theories. In this regard, a majority of empirical studies examined the case of developed countries, mainly the USA (Eun and Wang, 2015;Li and Singal, 2019;Macnamara, 2019;Morri and Parri, 2017), and the European Union (Acedo-Ramirez et al., 2017;Guida and Sabato, 2017;Garcia-Rodriguez and Jegers, 2017;Li and Islam, 2019;Moradi and Paulet, 2019;Schepens, 2016;Van Hoang et al., 2018). Empirical studies on the developing countries came to light with the study of Booth et al. (2001). ...
This study empirically investigated the determinants of capital leverage of the Chinese real estate sector. Annual panel data of 130 companies covering the period 2007–2017 were used. Profitability was treated as a latent variable to avoid any specification error. Structural equation modelling (SEM) confirmed that while the size and financial cost have a significant positive effect on the level of capital leverage; liquidity, tangibility, and non-debt tax shield (NTDS) have a significant negative effect. The findings provide supportive evidence for both the trade-off theory and the pecking order theory. An interesting outcome of our research is that despite the substantial difference in institutional structure between China and Western countries, the firm-specific determinants of leverage are partially similar between the two. The policy implications of our research are discussed in the conclusion section.
... In light of the theoretical background, a large number of empirical studies investigating the determinants of capital structure, which have been sorted under two main theories; that is the pecking order and trade-off theories. In this regard, a majority of empirical studies examined the case of developed countries, mainly the USA (Eun and Wang, 2015;Li and Singal, 2019;Macnamara, 2019;Morri and Parri, 2017), and the European Union (Acedo-Ramirez et al., 2017;Guida and Sabato, 2017;Garcia-Rodriguez and Jegers, 2017;Li and Islam, 2019;Moradi and Paulet, 2019;Schepens, 2016;Van Hoang et al., 2018). Empirical studies on the developing countries came to light with the study of Booth et al. (2001). ...
This study empirically investigated the determinants of capital leverage of the Chinese real estate sector. Annual panel data of 130 companies covering the period 2007-2017 were used. Profitability was treated as a latent variable to avoid any specification error. Structural equation modelling (SEM) confirmed that while the size and financial cost have a significant positive effect on the level of capital leverage; liquidity, tangibility, and non-debt tax shield (NTDS) have a significant negative effect. The findings provide supportive evidence for both the trade-off theory and the pecking order theory. An interesting outcome of our research is that despite the substantial difference in institutional structure between China and Western countries, the firm-specific determinants of leverage are partially similar between the two. The policy implications of our research are discussed in the conclusion section.
... Relationship lending plays also a role in determining firms' capital structure.Guida and Sabato (2017) use a unique dataset of European manufacturing firms, and measure relationship lending based on three dimensions (closeness, soft information, exclusivity) and relate them to firms' leverage. The authors find that the actual use of soft information increases leverage and only firms without soft information-intensive relationships increa ...
This paper analyzes data from a regional Italian bank to provide new evidence on the relationship between who, within a bank, approves a loan and the subsequent performance of the loan. The size of the bank and its pool of clients, who are primarily small- and medium-size firms, comprises characteristics of both relationship-based and transaction-based lending technologies. Our key finding is that the probability of loan default increases as the loan approval decision is made at higher levels of the lending-decision hierarchy. This evidence supports the primacy of relationship-lending technology relative to transaction-based lending technology.
Disparities in regional bank concentration within Colombia, an emerging economy, are studied to evaluate their effects in the book leverage of local enterprises. Analyzing the 2016–2021 financial statements of 18,812 companies established in the country, we find evidence that the book leverage of individual firms is significantly correlated with the concentration of bank lending within their geographical region. Specifically, increases in bank concentration result in book leverage increases. Leverage for the country’s largest firms has a significant and complex relationship with their region’s bank concentration. The largest firms enjoy significantly higher levels of book leverage in the country’s less concentrated areas. This higher leverage disappears as concentration increases and, in the most concentrated regions, their leverage is lower than that of their counterparts. This manuscript joins the growing works in the literature claiming the existence of factors within a geographical location that counter the absence in bank competition, allowing some firms to effectively access institutional finance and mitigate some of the negative effect of banking concentration.
Agricultural firms are characterized by significant investments, both in fixed capital and in working capital. To finance investments, in addition to equity capital, access to credit becomes essential. Concerning this topic, various researches have shown that agricultural firms have difficulty accessing credit, due to reduced average size of farms, often poor financial culture and difficulty in communicating with lenders.To facilitate relations between agricultural firms and lenders in Italy, various regulatory provisions, over time, have changed the regulatory framework of agricultural credit. The offer of credit lines is today wide, even if granting of credit favors larger and more structured firms, and credit is concentrated in a few Italian regions. Public intervention through guarantees, and the introduction of a non-possessory revolving pledge, have favored access to credit for agricultural firms in recent years.The business cases analyzed have highlighted how investments of firms in fixed capital for the purchase of plants, and working capital, for aging of productions, amplify financial needs of firms and make it necessary to evaluate financial sustainability of operations. Recent increase in loans for ESG investments, and consequent regulatory framework, can facilitate financing of agricultural firms, enhancing their social role also in favor of smaller firms, cooperatives and firms in disadvantaged areas.
Purpose – Firms prefer to have more than one bank relationship to secure the flow of funds for their operations, particularly in bank-based economies. On the other hand, banks lean toward expanding their customer base with firms already in the credit market. The purpose of this study is to investigate the effect of the number of bank relationships as a firm-specific determinant of capital structure and to discuss its impact on the banking sector.
Design/methodology/approach – A two-step system generalized method of the moments estimation method is used in this study. The sample comprises 213 Turkish non-financial, publicly listed firms with a positive shareholder’s value for the 2012–2017 period.
Findings – The findings show that the number of bank relationships increases the leverage of sample firms while the concentration in the banking sector decreases it. These rather intriguing findings are attributed to an under-the-counter credit policy that causes a high-risk shift and a curse of mainstream banks. Once the mainstream banks allocated credit to the firm, its credibility is consumed by the following banks, which is implied by the significantly negative relationship between bank concentration and firm leverage. This problem is defined as the mainstream bank curse in the study.
Originality/value – The previous literature focuses on the effects of the number of bank relationships on firm profitability, cost of debt and shareholder wealth. However, its impact on the capital structure has not yet been systematically investigated. To the authors’ knowledge, this is the first study to critically analyze the effect of the number of bank relationships on the capital structure. The findings will be of immense benefit to the banking sector and the regulatory bodies.
Local IPO waves occur when firms from different industries, but located in the same area, go public in the same time period. We classify IPOs within industry IPO waves and within local IPO waves, and see that the sub‐samples of IPOs on the wave by industry only slightly overlap IPOs on the wave by region; IPO waves by region are similar to IPO waves by industry: for example, early‐in‐the‐wave IPOs are equally more underpriced than late‐in‐the‐wave IPOs. We also find the listing decision is sensitive not only to high valuations of firms in the same industry but also to high valuations of firms in the same region but in different industries. Our results do not support information spillover as a driver of local IPO waves, as the post‐IPO fall in profitability is more pronounced for on‐the‐wave than for off‐the‐wave IPO firms and the IPO price revision is not sensitive to the information revealed by concurrent IPOs. Using a difference‐in‐difference approach, we show that regions hosting IPO waves experience a parallel increase in several economic ratios post the wave. Overall, our results provide support to local IPO waves originating in positive local shocks.
Despite the recent academic focus on the effects of the crisis on bank loan quality, a fully satisfying analysis of their causes is still missing, likely because of a lack of detailed information on bank-borrower relationships and the way loan decisions are taken within banks. Thanks to the availability of a large dataset provided us by a regional Italian bank for the three calendar years 2010-2012, we are able to describe changes occurred in the bank loan quality of 3,103 firms, primarily small-and medium-sized firms. Besides a generalized deterioration of the loan quality due to the crisis, our findings show that the loan quality (as measured by each loan rating) is largely influenced by how information is processed and used at the different hierarchical levels within the bank at the time of loan decisions. More specifically, the deterioration of loan quality increases as the loan approval decision is made at higher levels of the lending-decision hierarchy, while it decreases with the firm age, size and the proximity of firms to the bank. The latter result supports the primacy of relationship-lending technology relative to transaction-based lending technology.
Purpose
The purpose of this paper is to shed light on the deleveraging impact of the anti-corruption campaign since the 18th National Congress of the Communist Party of China (CPC) on private firms with political connections, relative to those without political connections.
Design/methodology/approach
In this paper, taking the anti-corruption campaign employed from the end of 2012 as an exogenous shock, the authors design a quasi-experiment difference-in-difference approach to examine how the loss and failure of political connections impacts private firms’ debt financing.
Findings
The authors find that the loss and failure of political connections following the anti-corruption campaign since the 18th CPC National Congress causes the yearly new debt ratios of treatment firms with political connections to decrease, relative to those of control firms without political connections. This outcome is more pronounced for provinces with more cadres excluded in the anti-corruption campaign since the 18th CPC National Congress, which rendered politically connected firms susceptible to lose connections with central or provincial cadres. To explore the mechanism, the authors find that following the anti-corruption campaign since the 18th CPC National Congress, politically connected firms limit rent-seeking activities, whereas resource acquisition is weakened. The authors also find that the impact of the anti-corruption campaign since the 18th CPC National Congress on the debt financing of politically connected firms, relative to their counterparts, is more pronounced for groups with high levels of information asymmetry and for less explicit guarantee groups. Finally, politically connected firms are more likely to be dominated by internal funds in dealing with a loss of advantages in debt financing, compared with their counterparts without political connections.
Research limitations/implications
The findings in this study suggest that the loss or failure of previous political connections following Xi’s anti-corruption campaign make politically connected firms lose the advantages in debt financing through the rent-seeking, resource acquisition, information asymmetry, implicit guarantee channels, which provide new evidence for research on the impact of the anti-corruption campaign since the 18th CPC National Congress on private firms’ financing behaviors via the loss or failure of existing political connections.
Practical implications
The findings in the study will have some inspiration for policy makers and entrepreneur.
Originality/value
This study provides new evidence on the different impacts of Xi’s anti-corruption campaign on private firm’s debt financing between politically connected and unconnected firms.
Using a novel information asymmetry index based on measures of adverse selection developed by the market microstructure literature, we test whether information asymmetry is an important determinant of capital structure decisions, as suggested by the pecking order theory. Our index relies exclusively on measures of the market's assessment of adverse selection risk rather than on ex ante firm characteristics. We find that information asymmetry does affect the capital structure decisions of U.S. firms over the sample period 1973--2002. Our findings are robust to controlling for conventional leverage factors (size, tangibility, Q ratio, profitability), the sources of firms' financing needs, and such firm attributes as stock return volatility, stock turnover, and intensity of insider trading. For example, we estimate that on average, for every dollar of financing deficit to cover, firms in the highest adverse selection decile issue 30 cents of debt more than firms in the lowest decile. Overall, this evidence explains why the pecking order theory is only partially successful in explaining all of firms' capital structure decisions. It also suggests that the theory finds support when its basic assumptions hold in the data, as should reasonably be expected of any theory. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.
In this article, I examine the effect of pre-existing relationships between a firm and its potential lender on the potential lender's decision whether or not to extend credit to the firm. I find that a potential lender is more likely to extend credit to a firm with which it has a pre-existing relationship as a source of financial services, but that the length of this relationship is unimportant. These findings provide empirical support for theories of financial intermediation positing that banking relationships generate valuable private information about the financial prospects of the financial institution's customer. The results also provide evidence that potential lenders are less likely to extend credit to firms with multiple sources of financial services, in support of the theory that the private information a financial institution generates about a firm is less valuable when the firm deals with multiple sources of financial services.
Bank deregulation and progress in information technology altered the geographical diffusion of banking structures and instruments, and reduced operational distance between banks and local economies. Although, the consolidation of the banking industry promoted the geographical concentration of banking decision-making centres and increased functional distance between local banking systems and local borrowers. This paper focuses on the impact that these spatial diffusion-concentration phenomena had on the financing constraints of Italian firms over the period 1996--2003. Our findings show that greater functional distance stiffened financing constraints, especially for small firms, while smaller operational distance did not always enhance credit availability. Copyright 2009, Oxford University Press.
The capital-structure decision is one of the most fundamental issues in corporate finance. Numerous studies have been conducted to test the two major competing theories of capital structure (Trade-Off Theory and Pecking-Order Theory), yet none of these studies has analyzed the capital-structure decisions of small, privately held U.S. firms, which constitute the vast majority of all U.S. business enterprises. In this study, we provide the first evidence on this important issue, utilizing data from four nationally representative surveys conducted by the Federal Reserve Board: the 1987, 1993, 1998 and 2003 Surveys of Small Business Finances (SSBF). We find that firm leverage as measured by the ratios of total loans to total assets and total liabilities to total assets is negatively related to firm size, age, profitability, liquidity and credit quality and is positively related to firm tangibility and limited liability. In addition, we find that firm leverage is an increasing function of both the number of banks and the number of non-bank financial institutions with which the firm has business relationships. Finally, we find no significant variations in firm leverage by race or ethnicity, but some evidence that femaleowned firms use less leverage. In general, these results are broadly supportive of the Pecking- Order Theory and inconsistent with the Trade-Off Theory.
Relationship lending is a common practice in credit financing all over the world, notably also in the European Union, which has been assumed to be particularly beneficial for Small and Medium-Sized Enterprises (SMEs). During recent years, there has been the impression that relationship lending loses ground due to a change of the banks' business models, which could ultimately yield to a worsening of the business environment for corporates and SMEs. In this study, we investigate the determinants of relationship lending for Germany, where relationship lending traditionally plays an important role. Compared to previous studies, we refer to much more comprehensive data with information on more than 16,000 firm-bank relationships. Our findings confirm the assumption that relationship lending seems to be an important pillar for economic growth and employment: We find that the firms that are most likely to contribute to (future) economic growth, namely small and R&D-intensive firms, tend to choose a relationship lender. The same is observed for firms of high credit quality, independent of their size or R&D intensity. Furthermore, we also observe that the importance of relationship lending did not decrease since the mid 1990s.
While existing literature has documented the benefits of relationship banking for small privately held businesses, there is little empirical work that examines whether lending relationships provide significant (if any) benefits to larger borrowers. Our paper addresses this question. Unlike earlier studies we analyze the effects of borrowing from relationship lenders for large borrowers who have access to public capital markets. We find that, on average, borrowing from a relationship lender translates into a 5 to 15 basis point lowering of interest rates for a large borrower and that these benefits are significantly larger for borrowers facing higher information asymmetries. We also examine other non-price features of large borrowers' loan facilities, such as maturity and collateral. Importantly, our's is the first paper to estimate the impact of these variables using a simultaneous equations approach which recognizes the joint determination of price and non-price terms. Our results show that large borrowers have a significantly lower probability of having to pledge collateral if the loan is from a relationship lender. Furthermore, relationship borrowers appear to enjoy access to larger debt financing and are therefore less credit constrained than non-relationship borrowers.
Customer relationships arise between banks and firms because, in the process of lending, a bank learns more than others about its own customers. This information asymmetry allows lenders to capture some of the rents generated by their older customers; competition, thus, drives banks to lend to new firms at interest rates that initially generate expected losses. As a result, the allocation of capital is shifted toward lower quality and inexperienced firms. This inefficiency is eliminated if complete contingent contracts are written or, when this is costly, if banks can make nonbinding commitments that, in equilibrium, are backed by reputation. Copyright 1990 by American Finance Association.
We review the contemporary theory of financial intermediation. The focus is on the contribution in the past 15 years or so that have advanced our understanding of why financial intermediaries exist, the credit allocation decision and other services they provide in spot and forward credit markets, the contractual nature and allocational consequences of the claims they issue, and the optimal design of bank regulation.
We find that repeated borrowing from the same lender translates into a 10-17 bps lowering of loan spreads and that relationships are especially valuable when borrower transparency is low. These results hold using multiple approaches (propensity score matching, instrumental variables, and treatment effects model) that control for the endogeneity of relationships. We also provide a demarcation line between relationship and transactional lending. Spreads charged for relationship loans and nonrelationship loans are statistically identical if the borrower is in the largest 30% by asset size; has public rated debt; or is part of the S&P 500 index. Past relationships reduce collateral requirements and are also associated with obtaining larger loans. Our results imply that, even for firms that have multiple sources of outside financing, borrowing from a prior lender obtains better loan terms. (Information asymmetry between lenders and borrowers has played a key role in the development of financial intermediation theory. If an owner/manager cannot credibly reveal the firm's future prospects, lenders must invest in costly information production and due diligence so as to assess the creditworthiness Bharath acknowledges the research support of the Ross School of Business, University of Michigan. Srinivasan acknowledges the support of NUS research grants R-315-000-066-112 and R-315-000-066-133. The authors thank seminar participants at the University of Michigan, Boston College, Wharton School of Business, Indian
This paper examines the relative importance of many factors in the capital structure decisions of publicly traded American firms from 1950 to 2003. The most reliable factors for explaining market leverage are: median industry leverage (+ effect on leverage), market-to-book assets ratio (-), tangibility (+), profits (-), log of assets (+), and expected inflation (+). In addition, we find that dividend-paying firms tend to have lower leverage. When considering book leverage, somewhat similar effects are found. However, for book leverage, the impact of firm size, the market-to-book ratio, and the effect of inflation are not reliable. The empirical evidence seems reasonably consistent with some versions of the trade-off theory of capital structure.
Prior work on leverage implicitly assumes capital availability depends solely on firm characteristics. However, market frictions
that make capital structure relevant may also be associated with a firm’s source of capital. Examining this intuition, we
find firms that have access to the public bond markets, as measured by having a debt rating, have significantly more leverage.
Although firms with a rating are fundamentally different, these differences do not explain our findings. Even after controlling
for firm characteristics that determine observed capital structure, and instrumenting for the possible endogeneity of having
a rating, firms with access have 35% more debt.
This paper tests the impact of an imperfect firm–bank type match on firms’ financial constraints using a dataset of about 4500 Italian manufacturing firms. Considering an optimal match of opaque (transparent) borrowing firms with relational (transactional) lending main banks, the possibility arises of firm–bank “odd couples” where opaque firms end up matched with transactional main banks. We show that the probability of credit rationing increases when the mismatch between firms and banks widens. Our conjecture is that “odd couples” emerge either because of organizational changes in the credit market or since firms observe only imperfectly banks’ lending technology.
The German financial market is often characterized as a bank-based system with strong bank–customer relationships. The corresponding notion of a housebank is closely related to the theoretical idea of relationship lending. It is the objective of this paper to provide a direct comparison between housebanks and “normal” banks as to their credit policy. Therefore, we analyze a new data set, representing a random sample of borrowers drawn from the credit portfolios of five leading German banks over a period of five years. We use credit-file data rather than industry survey data and, thus, focus the analysis on information that is directly related to actual credit decisions. In particular, we use bank-internal borrower rating data to evaluate borrower quality, and the bank’s own assessment of its housebank status to control for information-intensive relationships. The major results of our study support the view that housebanks are able to establish a distinct behavioral pattern consistent with the idea of long-term commitment. We find that housebanks do provide liquidity insurance in situations of unexpected deterioration of borrower ratings. With respect to loan pricing, we find no evidence for intra- or intertemporal price differentiation related to housebanking.
The widespread Italian practice of multiple borrowing has been studied with respect to the continuity of bank lending and to the interest rates charged to individual borrowers. However, there is a lack of empirical evidence on the effects of multiple credit relationships over the fragility of the corporate borrowers. Two theses are competing: one asserts that multiple borrowing results in a desirable sharing of risks; the other, that the parcellization of loans substantially weakens the discipline exercised by the banks and makes corporate borrowers more fragile. Through multivariate techniques, we check whether the indicators describing the structure of lending relationships can help, along with balance-sheet variables, to separate healthy from failed firms. This exercise shows that multiple banking relationships are associated with a higher riskiness of the borrowers, even though the impact is moderate in comparison with the importance of real and financial variables derived from balance sheets.
Abstract In the last two decades the European financial markets have become,more market oriented. We analyze the economic ,and political forces that have triggered these changes ,as well ,as their likely welfare implications. We also try to assess whether this trend will continue. Based on our analysis, we conjecture that even if Europe might benefit from a continuation of the trend, in the near future political support for it is likely to become much weaker. Furthermore, without serious reforms, the trend is likely to benefit Southern Europe less than Northern Europe. ,,,,,,,,,,,
Taxes, bankruptcy costs, transactions costs, adverse selection, and agency conflicts have all been advocated as major explanations for the corporate use of debt financing. These ideas have often been synthesized into the trade-off theory and the pecking order theory of leverage. These theories and the related evidence are reviewed in this survey. A number of important empirical stylized facts are identified. To understand the evidence, it is important to recognize the differences among private firms, small public firms and large public firms. Private firms seem to use retained earnings and bank debt heavily. Small public firms make active use of equity financing. Large public firms primarily use retained earnings and corporate bonds. The available evidence can be interpreted in several ways. Direct transaction costs and indirect bankruptcy costs appear to play important roles in a firm's choice of debt. The relative importance of the other factors remains open to debate. No currently available model appears capable of simultaneously accounting for all of the stylized facts.
This paper contrasts the "static tradeoff" and "pecking order" theories of capital structure choice by corporations. In the static tradeoff theory, optimal capital structure is reached when the tax advantage to borrowing is balanced, at the margin, by costs of financial distress. In the pecking order theory, firms preferinternal to external funds, and debt to equity if external funds are needed. Thus the debt ratio reflects the cumulative requirement for external financing. Pecking order behavior follows from simple asymmetric information models. The paper closes with a review of empirical evidence relevant to the two theories.
This study uses a new data set to assess whether capital structure theory is portable across countries with different institutional structures. We analyze capital structure choices of firms in 10 developing countries, and provide evidence that these decisions are affected by the same variables as in developed countries. However, there are persistent differences across countries, indicating that specific country factors are at work. Our findings suggest that although some of the insights from modern finance theory are portable across countries, much remains to be done to understand the impact of different institutional features on capital structure choices.
We find that repeated borrowing from the same lender translates into a 10--17 bps lowering of loan spreads and that relationships are especially valuable when borrower transparency is low. These results hold using multiple approaches (propensity score matching, instrumental variables, and treatment effects model) that control for the endogeneity of relationships. We also provide a demarcation line between relationship and transactional lending. Spreads charged for relationship loans and nonrelationship loans are statistically identical if the borrower is in the largest 30% by asset size; has public rated debt; or is part of the S&P 500 index. Past relationships reduce collateral requirements and are also associated with obtaining larger loans. Our results imply that, even for firms that have multiple sources of outside financing, borrowing from a prior lender obtains better loan terms. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.
We analyze the duration of bank relationships using a unique panel data set of listed firms and their banks from the bank-dominated Norwegian market. We find that firms are more likely to leave a bank as the relationship matures. Small, profitable, and highly leveraged firms maintain shorter bank relationships, as do firms with multiple bank relationships. These findings are robust to censoring, alternate specifications for the distribution of relationship duration, and other control variables relevant to the Norwegian market. Overall, our results cast doubt on theories suggesting that firms become locked into bank relationships.
This paper investigates a firm's choice between borrowing from a single bank and from two banks. The focus is on how this decision affects banks' equilibrium monitoring intensities and loan rates. Two-bank lending suffers from duplication of effort and sharing of monitoring benefits, but it benefits from diseconomies of scale in monitoring. Thus, two-bank lending involves lower monitoring but not necessarily higher loan rates than single-bank lending. The optimal borrowing structure balances the benefit of monitoring for the firm in terms of higher success probability of the project against its drawbacks of lower expected private return and higher total monitoring costs. In contrast to the previous theoretical literature, the model lays down an explanation for the empirical observation that multiple-bank lending does not unambiguously increase loan rates or firms' quality, in particular in small business lending.
We analyze the importance of firm-specific and country-specific factors in the leverage choice of firms from 42 countries around the world. Our analysis yields two new results. First, we find that firm-specific determinants of leverage differ across countries, while prior studies implicitly assume equal impact of these determinants. Second, although we concur with the conventional direct impact of country-specific factors on the capital structure of firms, we show that there is an indirect impact because country-specific factors also influence the roles of firm-specific determinants of leverage.
We test hypotheses about the effects of bank size, foreign ownership, and distress on lending to informationally opaque small firms using a rich new data set on Argentinean banks, firms, and loans. We also test hypotheses about borrowing from a single bank versus multiple banks. Our results suggest that large and foreign-owned institutions may have difficulty extending relationship loans to opaque small firms. Bank distress appears to have no greater effect on small borrowers than on large borrowers, although even small firms may react to bank distress by borrowing from multiple banks, raising borrowing costs and destroying some relationship benefits.
We examine empirically the role of lending relationships in determining the costs and collateral requirements for external funds. The data originate from a recently concluded survey of small and medium-sized German firms. In our descriptive analysis, we explore the borrowing patterns and the concentration of borrowing from financial institutions. Using data on L/C interest rates, collateral requirements, and the firm's use of fast payment discounts we find that relationship variables may have some bearing on the price of external funds, but much more so on loan collateralization and availability. Firms in financial distress face comparatively high L/C interest rates and reduced credit availability.
This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears these costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.The directors of such [joint-stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.Adam Smith, The Wealth of Nations, 1776, Cannan Edition(Modern Library, New York, 1937) p. 700.
We analyze a firm's optimal choice over the number of creditors and the extent of information disclosed to them. By dealing with many creditors and disclosing essential confidential information, a firm can keep its cost of credit low. This, however, is associated with a relatively high probability that valuable information leaks to competitors, leading to lower expected net returns from product market operations. The importance of these two countervailing effects varies with size, time, industry, and the form of the financial sector, which yields a number of empirically testable hypotheses.
We investigate the determinants of multiple-bank relationships using a new data set comprising 1079 firms across 20 European countries. We document large cross-country variation in the average number of bank relationships per firm, uncovering a richness in European financial systems that extends beyond the standard description of being “bank-dominated”. After controlling for a variety of firm-specific characteristics, we find that firms maintain more bank relationships, on average, in countries with inefficient judicial systems and poor enforcement of creditor rights. Firms also maintain more relationships in countries with unconcentrated but stable banking systems and active public bond markets. Journal of Economic Literature Classification Numbers: G21, C41.
ABSTRACT : This paper looks at how well Finland performs in high growth entrepreneurship and uses data from the Global Entrepreneurship monitor to benchmark Finland against other European countries. It is found that Finland’s prevalence rate of high growth entrepreneurial activity lags significantly behind most of its European and all of its Scandinavian peers. That this weak performance in high-growth entrepreneurship goes hand in hand with Finland being a world leader in per capita investment in R&D may be described as a paradox. The reasons underlying the underperformance of Finland remain however unclear. At this point, explanations should be sought in culture, industrial traditions and systemic experience in high growth entrepreneurship.
In this paper we model and empirically test the impact of banks' shift towards financial services on their screening activity and on the quality of their loans. We present a model where it is easier to sell services to positively evaluated loan applicants and we show that the larger the banks' income from services, the lower their optimal screening effort. This prediction is consistent with the empirical evidence based on a panel of European banks and showing that the quality of banks' loans decreases with the share of commission income (a proxy for income from services). Copyright © 2009 The Authors. Journal compilation © 2009 Blackwell Publishing Ltd and The University of Manchester.
This paper provides a survey on studies that analyze the macroeconomic effects of intellectual property rights (IPR). The first part of this paper introduces different patent policy instruments and reviews their effects on R&D and economic growth. This part also discusses the distortionary effects and distributional consequences of IPR protection as well as empirical evidence on the effects of patent rights. Then, the second part considers the international aspects of IPR protection. In summary, this paper draws the following conclusions from the literature. Firstly, different patent policy instruments have different effects on R&D and growth. Secondly, there is empirical evidence supporting a positive relationship between IPR protection and innovation, but the evidence is stronger for developed countries than for developing countries. Thirdly, the optimal level of IPR protection should tradeoff the social benefits of enhanced innovation against the social costs of multiple distortions and income inequality. Finally, in an open economy, achieving the globally optimal level of protection requires an international coordination (rather than the harmonization) of IPR protection.
"Business start-ups lack prior history and reputation, face high failure risk, and have highly concentrated ownership. The resulting information and incentive problems, combined with entrepreneurial private benefits of control, affect initial financing decisions. This paper examines simultaneously the impact of these issues on leverage, debt mix and maturity. We find that start-ups with high adverse selection and risk shifting problems contract less bank debt but compensate with other debt sources. Start-ups in growing industries have lower leverage, but raise more bank debt. Entrepreneurs with large private control benefits contract less but longer term bank loans to lower the default probability." Copyright 2007 The Authors Journal compilation (c) 2007 Blackwell Publishing Ltd.
Within an optimal contracting framework, the authors analyze the optimal number of creditors a company borrows from. They also analyze the optimal allocation of security interests among creditors and intercreditor voting rules that govern rule renegotiation of debt contracts. The key to the authors' analysis is the idea that these aspects of the debt structure affect the outcome of debt renegotiation following a default. Debt structures that lead to inefficient renegotiation are beneficial in that they deter default but they are also costly if default is beyond a manager's control. The optimal debt structure balances these effects. Copyright 1996 by University of Chicago Press.
This article examines the role of relationship lending in small firm finance. It examines price and nonprice terms of bank lines of credit extended to small firms. The focus on bank lines of credit allows the examination of a type of loan contract in which the bank-borrower relationship is likely to be an important mechanism for solving the asymmetric information problems associated with financing small enterprises. The authors find that borrowers with longer banking relationships pay lower interest rates and are less likely to pledge collateral. These results are consistent with theoretical arguments that relationship lending generates valuable information about borrower quality. Copyright 1995 by University of Chicago Press.
We study a credit model where, because of adverse selection, unprofitable projects may nevertheless be financed. Indeed they
may continue to be financed even when shown to be low-quality if sunk costs have already been incurred. We show that credit
decentralization offers a way for creditors to commit not to refinance such projects, thereby discouraging entrepreneurs from
undertaking them initially. Thus, decentralization provides financial discipline. Nevertheless, we argue that it puts too
high a premium on short-term returns.
The model seems pertinent to two issues: “soft budget constraint” problems in centralized economies, and differences between
“Anglo-Saxon” and “German-Japanese” financing practices.
The purpose of this paper is to shed more light on the determinants of the number of bank lending relationships. In particular we look at the link between over-leverage and the number of banking relationships for a sample of Italian manufacturing firms, distinguishing between firms with a main bank and firms without a main bank. The main result of the paper is that the number of banking relationships increases with over-leverage only for firms without a main bank. We argue that this result is consistent with the view that, when banks perform transaction lending, firms can increase their debt capacity by increasing the number of creditors, promising ex ante up to the full amount of available assets to each one of the creditors. Copyright © 2006 The Authors; Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester.
This paper asks how well different organizational structures perform in terms of generating information about investment projects and allocating capital to these projects. A decentralized approach-with small, single-manager firms-is most likely to be attractive when information about projects is "soft" and cannot be credibly transmitted. In contrast, large hierarchies perform better when information can be costlessly "hardened" and passed along inside the firm. The model can be used to think about the consequences of consolidation in the banking industry, particularly the documented tendency for mergers to lead to declines in small-business lending. Copyright The American Finance Association 2002.
This article examines the determinants of the mix of private and public debt using detailed information on the debt structure of 250 publicly traded corporations from 1980 through 1990. The authors find that the relationship between bank borrowing and the importance of growth opportunities depends on the number of banks the firm uses and whether the firm has public debt outstanding. For firms with a single bank relationship, the reliance on bank debt is negatively related to the importance of growth opportunities. In contrast, among firms borrowing from multiple banks, the relationship is positive. Copyright 1996 by American Finance Association.
This paper surveys capital structure theories based on agency costs, asymmetric information, product/input market interactions, and corporate control considerations (but excluding tax-based theories). For each type of model, a brief overview of the papers surveyed and their relation to each other is provided. The central papers are described in some detail, and their results are summarized and followed by a discussion of related extensions. Each section concludes with a summary of the main implications of the models surveyed in the section. Finally, these results are collected and compared to the available evidence. Suggestions for future research are provided. Copyright 1991 by American Finance Association.
In the last two decades the European financial markets have become more market-oriented. We analyse the economic and political forces that have triggered these changes as well as their likely welfare implications. We also try to assess whether this trend will continue. Based on our analysis, we conjecture that even if Europe might benefit from a continuation of the trend, in the near future political support for it is likely to become much weaker. Furthermore, without serious reforms, the trend is likely to benefit Southern Europe less than Northern Europe.
This paper briefly reviews the contemporary literature on relationship banking. We start out with a discussion of the raison d'être of banks in the context of the financial intermediation literature. From there we discuss how relationship banking fits into the core economic services provided by banks and point at its costs and benefits. This leads to an examination of the interrelationship between the competitive environment and relationship banking as well as a discussion of the empirical evidence. Journal of Economic Literature Classification Numbers: G20, G21, L10.
We contrast equilibria in loan markets with bilateral bank-borrower ties, in which proprietary technological knowledge of borrowers is not revealed to product market competitors, with equilibria under multilateral financing in which such knowledge may be shared among competing borrowing firms. Using each of these two institutional arrangements, we examine the conditions for existence of equilibrium, its ex ante optimality, and borrowing firms′ incentives to engage in private costly research. Also explored is the potential for lending banks to coordinate postinvention collusion in product markets by multiple inventing firms. Journal of Economic Literature Classification Numbers: 310, 312, 314.
This paper considers a firm that must issue common stock to raise cash to undertake a valuable investment opportunity. Management is assumed to know more about the firm's value than potential investors. Investors interpret the firm's actions rationally. An equilibrium model of the issue-invest decision is developed under these assumptions. The model shows that firms may refuse to issue stock, and therefore may pass up valuable investment opportunities. The model suggests explanations for several aspects of corporate financing behavior, including the tendency to rely on internal sources of funds, and to prefer debt to equity if external financing is required. Extensions and applications of the model are discussed.
A theory of the optimal number of banking relationships is developed and tested using matched bank-firm data. According to the theory, relationship banks may be unable to continue funding profitable projects owing to internal problems and a firm may thus have to refinance from nonrelationship banks. The latter, however, face an adverse selection problem, as they do not know the quality of the project, and may refuse to lend. In these circumstances, multiple banking can reduce the probability of an early liquidation of the project. The empirical evidence supports the predictions of the model. Copyright The American Finance Association 2000.
The authors investigate the determinants of capital structure choice by analyzing the financing decisions of public firms in the major industrialized countries. At an aggregate level, firm leverage is fairly similar across the G-7 countries. The authors find that factors identified by previous studies as correlated in the cross-section with firm leverage in the United States are similarly correlated in other countries as well. However, a deeper examination of the U.S. and foreign evidence suggests that the theoretical underpinnings of the observed correlations are still largely unresolved. Copyright 1995 by American Finance Association.
This paper empirically examines how ties between a firm and its creditors affect the availability and cost of funds to the firm. The authors analyze data collected in a survey of small firms by the Small Business Administration. The primary benefit of building close ties with an institutional creditor is that the availability of financing increases. The authors find smaller effects on the price of credit. Attempts to widen the circle of relationships by borrowing from multiple leaders increases the price and reduces the availability of credit. In sum, relationships are valuable and appear to operate more through quantities rather than prices. Copyright 1994 by American Finance Association.