Financial Advisor Reputation and the Cost of Debt: Theory and Evidence from Project Finance Loans

60 Pages Posted: 3 Oct 2017 Last revised: 25 Aug 2019

See all articles by Djerry C. Tandja M.

Djerry C. Tandja M.

Université du Québec en Outaouais

Gabriel Power

Université Laval - Département de Finance et Assurance

Issouf Soumaré

Laval University

Date Written: October 3, 2017

Abstract

An important puzzle in credit markets is why some firms use the services of financial advisors (FA) rather than undertake those tasks themselves. This paper examines, using theory and empirical evidence, whether the presence and the reputation of FA can act as a credible signal of project quality. Our theoretical model shows that, because of the structure of success fees, project lenders may worry that FA will try to sell them excessively risky projects, leading to higher costs of debt. Using Projectware data on project finance (PF) loans granted to public-private partnership projects arranged between 2001 and 2015, we test empirically and find strong support for our theoretical prediction. Indeed, our empirical results show that the presence and the reputation of FA are associated with higher costs of debt. Moreover, the evidence shows that FA presence and reputation are linked to higher project debt ratios. Overall, our findings suggest that the structure of success fees offers strong incentives to FA to focus on providing high debt levels rather on reducing asymmetric information between sponsors and lenders. Therefore, the presence and reputation of FA do not seem to be credible signaling devices for quality in the market for project finance loans.

Keywords: Financial intermediation, Asymmetric information, Market signaling, Cost of debt, Project finance, Public-private partnership

JEL Classification: F34, G21, D82

Suggested Citation

Tandja M., Djerry C. and Power, Gabriel and Soumaré, Issouf, Financial Advisor Reputation and the Cost of Debt: Theory and Evidence from Project Finance Loans (October 3, 2017). Available at SSRN: https://ssrn.com/abstract=3046219 or http://dx.doi.org/10.2139/ssrn.3046219

Djerry C. Tandja M. (Contact Author)

Université du Québec en Outaouais ( email )

Case postale 1250
succursale Hull
Gatineau, Québec J8X 3X7
Canada

Gabriel Power

Université Laval - Département de Finance et Assurance ( email )

Pavillon Palasis-Prince
Quebec G1K 7P4
Canada

Issouf Soumaré

Laval University ( email )

Faculty of Business Administration
Department of Finance, Insurance and Real Estate
Quebec, Quebec G1V 0A6
Canada
1418 656 3423 (Phone)
1418 656 2624 (Fax)

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