Session 5: Market Discipline and Bank-Firm Relationship Leora F. Klapper World Bank Conference on Bank Regulation and Corporate Finance: Challenges for the Future October 26-27, The opinions expressed do not necessarily represent the views of the World Bank.

Main Hypotheses Bank lending relationships – measured by distance and # of lenders – affect borrowing firms: Bank lending relationships – measured by distance and # of lenders – affect borrowing firms: – Asymmetric information of the firms stock (+) – Stock liquidity (-) – Trading volume (-) – Trading by institutional investors (-) – Stock volatility (-) – Cashflow (-) – Managerial appropriation (-) – Trading by managers (?) – Expenditures on M&A (?) – CEO turnover (+) – Tobins Q (?/+) Variables well embedded in previous theoretical and empirical literature Variables well embedded in previous theoretical and empirical literature Nice extension of previous literature on mult banking Nice extension of previous literature on mult banking

The Loan Syndication Market The market for loan participation is so brisk that borrowers sometimes do not know exactly which bank is financing them – White & Case Syndicated credit lie somewhere between relationship loans and disintermediated debt – Dennis and Mullineaux (2000) A syndicated loan deal generally consists of: A syndicated loan deal generally consists of: – An arranger or lead manager, generally one (or more) banks chosen by the borrower – usually from among its existing relationship banks – to put the deal together; is responsible for structuring the loan facility, including negotiating the pricing and terms and conditions. – The key issues for the lead bank in designing a syndication strategy include how many banks to invite, which banks to invite, what fees to offer, and what share of the loan to hold in the end (Esty, 2000) –The remaining syndicate, or consortium, of banks generally simply provide funds for the loan. A syndicate, or consortium, of banks act as a single financier, based on a single loan agreement. The participating banks split and allocate the risks connected with the loan. In case of disputes, all banks must concur with the majority vote In case of disputes, all banks must concur with the majority vote Roberts and Panyagometh (2004), Sufi (2006) Roberts and Panyagometh (2004), Sufi (2006) The arranger generally takes all steps related to the syndicated loan, such as the in-depth assessment of the borrower's credit rating, the compilation of the loan documentation, the commissioning of the assisting legal firm, and the negotiations with the borrower that follow the first contact. The borrower communicates exclusively with the arranger (or co-arrangers). The arranger generally takes all steps related to the syndicated loan, such as the in-depth assessment of the borrower's credit rating, the compilation of the loan documentation, the commissioning of the assisting legal firm, and the negotiations with the borrower that follow the first contact. The borrower communicates exclusively with the arranger (or co-arrangers).

The Loan Syndication Market Advantages to the borrower: May negotiate a higher total sum of borrowed funds May negotiate a higher total sum of borrowed funds It is not necessary to enter personal negotiations with each and every one of the financing banks It is not necessary to enter personal negotiations with each and every one of the financing banks The terms and conditions agreed in the syndicated loan agreement equally bind all of the participating banks. The terms and conditions agreed in the syndicated loan agreement equally bind all of the participating banks. Advantages to the lenders: Participating banks are usually entitled to transfer their proportion of the loan to a third party without the borrower's consent. It may thus happen that a bank that originally participated in the syndicate sells its share, and a new bank - the transferee - enters the syndicate, without the borrower being aware of these transactions.; Quite often, banks that participate in syndicated deals later sell their interest in those loans to other investors. Participating banks are usually entitled to transfer their proportion of the loan to a third party without the borrower's consent. It may thus happen that a bank that originally participated in the syndicate sells its share, and a new bank - the transferee - enters the syndicate, without the borrower being aware of these transactions.; Quite often, banks that participate in syndicated deals later sell their interest in those loans to other investors. The total value of syndicated loans traded in the secondary market rose to almost $145 billion in 2003, a 30 percent increase over the previous year, according to Loan Pricing. The total value of syndicated loans traded in the secondary market rose to almost $145 billion in 2003, a 30 percent increase over the previous year, according to Loan Pricing. –25% of total syndicated loans between 1993 and 2003 were sold –25% of total syndicated loans between 1993 and 2003 were sold

The Loan Syndication Market In U.S., syndicated loans totaled over $2 trillion in In U.S., syndicated loans totaled over $2 trillion in According to LPC, companies are increasingly turning to the syndicated loan market to fund acquisitions or pay down more expensive debt. According to LPC, companies are increasingly turning to the syndicated loan market to fund acquisitions or pay down more expensive debt.

Measures of Relationship Proximity: fraction of loans from banks whose headquarters are within 200 miles of the borrower Proximity: fraction of loans from banks whose headquarters are within 200 miles of the borrower Average Distance: average distance of the borrower from each bank Average Distance: average distance of the borrower from each bank – What about local branches? – Use of syndicated lending for geographical diversification For robustness, use distance of lead bank For robustness, use distance of lead bank

Measures of Relationship Exclusivity: log of the Herfindahl index of the lending syndicate Exclusivity: log of the Herfindahl index of the lending syndicate Dispersedness: log number of lenders Dispersedness: log number of lenders –Minimum number of relationships is two: no exclusive relationships Table 2a is not exactly a loan-taking decision; rather the decision to use a syndicated loan (rather than 1 bank or relationships with more than one bank) Table 2a is not exactly a loan-taking decision; rather the decision to use a syndicated loan (rather than 1 bank or relationships with more than one bank) –Multiple banking literature generally studies decision between one and more than one lender Banks in syndication do not necessarily have a relationship with the borrower Banks in syndication do not necessarily have a relationship with the borrower Include loan size, rather than firm size Include loan size, rather than firm size Explore uniqueness of syndicated lending relationship Explore uniqueness of syndicated lending relationship