The Role of Covenants in Mitigating Conflicts of Interest Within Lending Syndicates
59 Pages Posted: 19 Aug 2011
Date Written: March 1, 2011
We study the role of covenants in syndicated bank loans. We argue that, in addition to being a device for monitoring the borrower, covenants can help mitigate conflicts of interest between the lead arranger and participating banks in the syndicate. Such disagreements can arise when, for instance, a lead arranger has the incentive to support a poorly performing borrower and/or offer loan modifications while other syndicate lenders may prefer to discipline the borrower by accelerating the loan or enforcing default. We develop a simple model reflecting such conflicts and find empirical support for its predictions that covenants are less likely to be present: (i) in non-syndicated versus syndicated loans; (ii) when the lead's loan allocation is greater; and (iii) when participating bank affiliates hold substantial equity in the borrower. Consistent with this evidence, we find that lead arrangers are more likely to syndicate with banks that hold borrower's equity through affiliated entities.
Keywords: Bank Loans, Conflict of Interest, Covenants, Lending Syndicate, Monitoring
JEL Classification: G20, G21, G32
Suggested Citation: Suggested Citation