The Role of Dynamic Renegotiation and Asymmetric Information in Financial Contracting

Abstract:     
Using hand-collected data from SEC filings, we show that bank loans are repeatedly renegotiated in order to modify contractual constraints designed to mitigate information related problems. The typical loan is renegotiated every eight months, or four times during the life of the contract. The financial health of the contracting parties, the uncertainty of the borrower’s credit quality, and the purpose of the renegotiation govern the timing of these renegotiations. However, the relative importance of these factors depends critically on when in the relationship the renegotiation occurs. This temporal dependence reflects a decline in information asymmetry during the lending relationship such that lenders can write more efficient contracts and rely more heavily on observable signals of borrower credit quality when amending the contracts.

Number of Pages in PDF File: 57

Keywords: Contract Renegotiation, Asymmetric Information, Bank Loans, Financial Contracting

JEL Classification: G21, G32, L14, K12

working papers series