Two-part pricing of corporate bank loans with penalty-free prepayment

54 Pages Posted: 26 Nov 2011 Last revised: 7 Jan 2022

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)

Multiple version iconThere are 2 versions of this paper

Date Written: December 19, 2021

Abstract

Corporate bank loans typically include the option to prepay the loan without penalty. In a two-part loan-pricing model with dynamic learning, where ex post high-quality borrowers optimally prepay, we show that an upfront fee in combination with a lower loan spread resolves credit rationing for borrowers with high risk of prepayment. As predicted, large-sample evidence, which includes exogenous industry-level variation in loan prepayment risk, confirms that upfront fees are increasing in prepayment risk. We also discuss loans with performance-sensitive pricing, and why banks may prefer the penalty-free prepayment option over a cancellation fee.

Keywords: bank loans, prepayment, credit rationing, upfront fee, performance-pricing

JEL Classification: D82, D86, G21, G32

Suggested Citation

Eckbo, B. Espen and Su, Xunhua and Thorburn, Karin S., Two-part pricing of corporate bank loans with penalty-free prepayment (December 19, 2021). Tuck School of Business Working Paper No. 1964843, European Corporate Governance Institute – Finance Working Paper No. 770/2021, 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://tuck.dartmouth.edu/faculty/faculty-directory/b-espen-eckbo

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 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/

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 the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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

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