How Major Customers Affect Supplier Loan Yield and Covenants

Posted: 11 Jan 2011

See all articles by Wei Chern Koh

Wei Chern Koh

Nanyang Business School, Nanyang Technological University; SIM University (UniSIM)

Siew Hong Teoh

UCLA Anderson School of Management

T. Mandy Tham

Nanyang Technological University (NTU); Singapore Management University - Lee Kong Chian School of Business

Date Written: December 30, 2010

Abstract

Using a sample of private loans issued to U.S. firms between 1994 and 2006, we examine whether lenders take into account the relationship of the borrower-supplier with its major customers when determining loan yields, dividend restriction covenant and the overall number of financial covenants at loan initiations. A supplier that is economically dependent on its major customers can import its customers' liquidity problems as well as succumb to pressure from its customers to engage in risk-shifting behaviors that expropriate the lender. We find evidence that lenders protect themselves from such liquidity contagion and expropriation by imposing higher loan yields, a larger number of financial covenants, and dividend restriction covenants on the supplier-borrower when the major customers have high risk and leverage. Yield also increases when the borrower relies on a greater number of major customers, when major customers contribute to a higher percentage of its sales, and when it has a shorter working relationship with its most important customer. These findings suggest that lenders consider additional sources of default risk of the borrower arising from important customer-supplier relationship when designing loan contracts to take into account additional monitoring costs, hold-up problems, and potential bailout benefits from the borrower’s major customers.

Keywords: economic links, financial covenants, loan yield, major customers, customer-supplier relationships, default risk

JEL Classification: G21, G32, G34, L14

Suggested Citation

Koh, Wei Chern and Koh, Wei Chern and Teoh, Siew Hong and Tham, Tze-Minn and Tham, Tze-Minn, How Major Customers Affect Supplier Loan Yield and Covenants (December 30, 2010). CAAA Annual Conference 2011, Available at SSRN: https://ssrn.com/abstract=1732383 or http://dx.doi.org/10.2139/ssrn.1732383

Wei Chern Koh (Contact Author)

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore

SIM University (UniSIM) ( email )

461 Clementi Road
Singapore, 599491
Singapore

Siew Hong Teoh

UCLA Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

HOME PAGE: http://www.anderson.ucla.edu/faculty-and-research/accounting/faculty/teoh

Tze-Minn Tham

Nanyang Technological University (NTU) ( email )

S3 B1b-61 Nanyang Avenue
Singapore, 639798
Singapore
65-67906049 (Phone)

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
Singapore 178899
Singapore

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