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What's Bank Reputation Worth? The Effect of Fraud on Financial Contracts and Investment

58 Pages Posted: 1 Jul 2009 Last revised: 17 Aug 2011

Huidan Lin

International Monetary Fund

Daniel Paravisini

London School of Economics & Political Science (LSE)

Date Written: June 1, 2011

Abstract

The risk of a reputation loss can provide an informal enforcement mechanism when contracts are incomplete. This paper provides evidence that reputation and formal incentives to monitor are substitutes in the context of syndicated credit. Monitoring in a loan syndicate is delegated to lead banks, whose formal incentives are determined by their share of the loan. Exploiting as a source of variation the reputation loss suffered by banks actively lending to firms subsequently involved in fraud scandals, we use within-firm estimators to show that monitoring banks face higher-powered contracts - higher loan shares - after a reputation loss. Despite this substitution, banks supply less credit and borrower financial policy and investment are affected, indicating that formal incentives are an imperfect substitute for reputation.

Keywords: Banking, Reputation, Commitment, Investment

JEL Classification: G21, G31

Suggested Citation

Lin, Huidan and Paravisini, Daniel, What's Bank Reputation Worth? The Effect of Fraud on Financial Contracts and Investment (June 1, 2011). Available at SSRN: https://ssrn.com/abstract=1427330 or http://dx.doi.org/10.2139/ssrn.1427330

Huidan Lin

International Monetary Fund ( email )

700 19th Street
Washington D.C., DC 20431
United States

Daniel Paravisini (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

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