Bank Skin in the Game and Loan Contract Design: Evidence from Covenant-Lite Loans

70 Pages Posted: 3 Nov 2012 Last revised: 12 May 2014

See all articles by Matthew T. Billett

Matthew T. Billett

Indiana University - Kelley School of Business - Department of Finance

Redouane Elkamhi

University of Toronto - Rotman School of Management

Latchezar Popov

University of Virginia

Raunaq S. Pungaliya

Sungkyunkwan University (SKK) Graduate School of Business

Date Written: August 2013

Abstract

In a model of dual agency problems where borrower-lenders and bank-nonbank incentives may conflict, we predict a hockey stick relation between bank skin in the game and covenant tightness. As bank participation declines covenant tightness increases until reaching a low threshold, at which point the relation sharply reverses and covenant protection is removed with a commensurate increase in spread. We find support for the hockey stick relation with banks stake in covenant-lite loans averaging 8% (0% median). We also find that covenant-lite loans are more likely when borrower moral hazard is less severe and when bank relationship rents are high.

Keywords: Covenants, Debt contracting, Syndicated Loans, Bank loans, Agency Costs

JEL Classification: D86, G21, G23, G32, L14, M41

Suggested Citation

Billett, Matthew T. and Elkamhi, Redouane and Popov, Latchezar and Pungaliya, Raunaq S., Bank Skin in the Game and Loan Contract Design: Evidence from Covenant-Lite Loans (August 2013). Available at SSRN: https://ssrn.com/abstract=2169624 or http://dx.doi.org/10.2139/ssrn.2169624

Matthew T. Billett

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3366 (Phone)

Redouane Elkamhi

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Latchezar Popov

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

Raunaq S. Pungaliya (Contact Author)

Sungkyunkwan University (SKK) Graduate School of Business ( email )

53 Myeongnyun-dong 3-ga Jongno-ju
Guro-gu
Seoul, 110-745
Korea, Republic of (South Korea)

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