Competition or Collaboration? The Reciprocity Effect in Loan Syndication

56 Pages Posted: 24 Apr 2010

See all articles by Jian Cai

Jian Cai

Washington University in St. Louis

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Date Written: April 15, 2010


It is well recognized that loan syndication generates a moral hazard problem by diluting the lead arranger’s incentive to monitor the borrower. This paper proposes and tests a novel view that reciprocal arrangements among lead arrangers serve as an effective mechanism to mitigate this agency problem. Lender arrangements in about seven out of ten syndicated loans are reciprocal in the sense that lead arrangers also participate in loans that are led by their participant lenders. Syndicate lenders share reciprocity through such arrangements as they can mutually benefit from each other’s monitoring effort. In fear of losing this reciprocity, lead arrangers will dutifully monitor their borrowers. Loans arranged in such a reciprocal way thus feature reduced moral hazard. I find strong empirical evidence that is consistent with the reciprocity effect. Controlling for lender, borrower, and loan characteristics, I show that: (i) lead arrangers retain on average 4.3% less of the loans with reciprocity than those without reciprocity, (ii) the average interest spread over LIBOR on drawn funds is 11 basis points lower on loans with reciprocity, and (iii) the default probability is 4.7% lower among loans with reciprocity. These results indicate a cooperative equilibrium in loan syndication and have important implications to lending institutions, borrowing firms, and regulators.

Keywords: Debt Overhang, Default, Credit Risk, Financial Frictions, Financial-Accelerator

JEL Classification: E32, E44

Suggested Citation

Cai, Jian, Competition or Collaboration? The Reciprocity Effect in Loan Syndication (April 15, 2010). FRB of Cleveland Policy Discussion Paper No. 09-09R, Available at SSRN:

Jian Cai (Contact Author)

Washington University in St. Louis ( email )

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