Penalty-free Prepayment and Upfront Fees in Bank Loans

48 Pages Posted: 26 Nov 2011 Last revised: 6 Sep 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: September 6, 2019

Abstract

Corporate term loans typically include a penalty-free prepayment option. In a model where borrowers strategically prepay, we show that high prepayment risk can trigger credit rationing by the bank. However, an upfront fee, which allows the bank to lower the loan spread and therefore the prepayment risk, restores an equilibrium with funding. Large-sample tests reveal that upfront fees are positively associated with proxies for loan prepayment risk and lower for performance-sensitive debt, as the theory predicts. Higher prepayment risk caused by exogenous merger activity in the industry of the borrower also increases upfront fees as predicted.

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., Penalty-free Prepayment and Upfront Fees in Bank Loans (September 6, 2019). Tuck School of Business Working Paper No. 1964843. 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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