Why the MAC Clause is so Ubiquitous in Bank Loan Commitments Although it is Hardly Ever Invoked
27 Pages Posted: 16 Aug 2013
Date Written: August 13, 2013
Many loan commitment contracts contain a material adverse change clause which allows banks to renege or step back from their commitment based on rather subjective claims regarding the borrowers' prospective financial situation. While this sounds like an attractive option for banks, empirical evidence shows that, despite its frequent appearance in contracts, the clause is rarely invoked (cf. Sufi, 2009; Ivashina and Scharfstein, 2010). In the present paper, we argue that this is due to the fact that, in combination with appropriate pricing on the spot loan market, the clause is essentially an effective means to screen the borrowers' riskiness. In particular, it renders loan commitment contracts comparably more expensive for high-risk borrowers, thereby directing them to the spot loan market. Low-risk borrowers, in turn, are still attracted to loan commitment contracts as for them the implicit extra cost is lower. Thus, in equilibrium, there is no need for banks to step back from earlier promises. Moreover, we show that the presence of the clause increases welfare as it decreases credit rationing for low-risk entrepreneurs and reduces total loan costs.
Keywords: loan commitment, MAC clause, asymmetric information, financial intermediation
JEL Classification: G21, D82
Suggested Citation: Suggested Citation