Lock-In Effects in Relationship Lending: Evidence from Dip Loans
Gabelli School of Business, Fordham University; Bank of Finland
Gabriel G. Ramirez
Kennesaw State University - Michael J. Coles College of Business
University of Missouri at St. Louis - College of Business Administration
Nov 1, 2012
Do prior lending relationships result in pass-through savings (lower interest rates) for borrowers, or do they lock in higher costs for borrowers? Theoretical models suggest that when borrowers experience greater information asymmetry, higher switching costs, and limited access to capital markets, they become locked into higher costs from their existing lenders. Firms in Chapter 11 seeking debtor-inpossession (DIP) financing often fit this profile. We investigate the presence of lock-in effects using a sample of DIP loans. We first account for selectivity bias by using the inverse mills ratio form a first stage. Then, in a second stage, we jointly estimate the relationship between loan price and non-price terms accounting for selectivity bias. We find that the existence and intensity of prior lending relationships are associated with higher interest costs, longer maturities, and smaller DIP loans. Taken together, our study provides direct evidence that prior lending relationships do create a lock-in effect under certain circumstances, such as DIP financing.
Number of Pages in PDF File: 33
Keywords: relationship lending, DIP financing, bank loans, lock-in effects, debtor-in-possession, financial intermediaries, lending practices
JEL Classification: G21
Date posted: March 15, 2011 ; Last revised: November 14, 2012
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