Upfront Fees and Prepayment Risk in Bank Loans

43 Pages Posted: 26 Nov 2011 Last revised: 17 Jan 2019

See all articles by B. Espen Eckbo

B. Espen Eckbo

Tuck School of Business at Dartmouth; European Corporate Governance Institute (ECGI)

Xunhua Su

Norwegian School of Economics (NHH)

Karin S. Thorburn

Norwegian School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: January 15, 2019

Abstract

Commercial and industrial term loans typically allow the borrow to prepay the loan without penalty. We develop and test a simple theoretical framework in which ex-post high-quality firms strategically prepay after receiving a private non-contractible signal about investment project quality. In the model, the prepayment option may triggers credit rationing unless the bank charges an upfront fee. Large-sample empirical tests show that upfront fees increase with prepayment risk, which is consistent with the model prediction. Furthermore, we show that upfront fees are higher after an exogenous shock to prepayment risk (instrumented with industry merger activity) and lower for performance-sensitive debt and credit lines, also as predicted by our model framework.

Keywords: credit rationing, upfront fee, borrower risk, performance-pricing, security, collateral

JEL Classification: D82, D86, G21, G32

Suggested Citation

Eckbo, B. Espen and Su, Xunhua and Thorburn, Karin S., Upfront Fees and Prepayment Risk in Bank Loans (January 15, 2019). Available at SSRN: https://ssrn.com/abstract=1964843 or http://dx.doi.org/10.2139/ssrn.1964843

B. Espen Eckbo

Tuck School of Business at Dartmouth ( email )

Hanover, NH 03755
United States
603-646-3953 (Phone)
603-646-3805 (Fax)

HOME PAGE: http://www.tuck.dartmouth.edu/eckbo

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Xunhua Su (Contact Author)

Norwegian School of Economics (NHH) ( email )

Helleveien 30
Bergen, NO-5045
Norway

HOME PAGE: http://sites.google.com/site/xunhuasu/research

Karin S. Thorburn

Norwegian School of Economics ( email )

Helleveien 30
N-5045 Bergen
Norway
+4755959283 (Phone)

HOME PAGE: http://www.nhh.no/cv/thorburn

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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