Within-Syndicate Conflicts and Financial Contracts: Evidence from Bank Loans
63 Pages Posted: 26 Jan 2012
Date Written: January 19, 2012
Using a sample of bank loans, we study how financial contracts are different when there are conflicts of interest not only between the contracting parties but within one of the contracting parties. Such conflicts can arise in lending syndicates when, for instance, the lead arranger has the incentive to support a poorly performing borrower while other syndicate participants do not. We argue that, in addition to being a device for monitoring the borrower, covenants enhance decision rights of participating lenders and can reduce the cost of intra-syndicate disagreements. We develop a simple model and find empirical support for its predictions: covenants are more likely to be present in syndicated loans and when conflicts of interest within the syndicate are greater (e.g., when participating banks' affiliates hold little equity in the borrower or when the lead arranger has a past lending relationship with the borrower). We also find that the potential for conflicts affects the choice of syndicate partners and that covenants substitute for lead arranger's loan allocation in mitigating conflicts.
Keywords: Bank Loans, Conict of Interest, Covenants, Lending Syndicate, Monitoring
JEL Classification: G20, G21, G32
Suggested Citation: Suggested Citation