Offshore Operations and Bank Loan Contracting: Evidence from Firms that Set Up Subsidiaries in Offshore Financial Centers
65 Pages Posted: 13 Dec 2014 Last revised: 10 Nov 2015
Date Written: February 13, 2015
We examine the effects of a multinational firm’s operations in offshore financial centers (OFCs) on the price and non-price terms of bank loan contracts. Using a sample of firms from 38 countries that have at least one subsidiary in an OFC, we find that intensive offshore operations are associated with unfavorable loan terms, such as higher loan spreads, smaller loan amounts, a higher probability of a loan being secured by collateral, and more prevalent use of restrictive covenants in a loan contract. To address potential endogeneity with respect to the relation between offshore operations and loan terms, we perform firm-fixed effects analyses, reexamine the relation between the two, using the announcement of OFC black and grey lists by the Organization for Economic Co-operation and Development (OECD) in 2002 as an exogenous shock, and analyze the dynamic link between increasing new subsidiaries in poorly-regulated OFCs and loan terms. The results indicate that the intensity of offshore operations affects loan terms unfavorably. We also find that such effects are more pronounced for more opaque firms and for firms that are headquartered in countries or jurisdictions with weaker legal or regulatory enforcement. Our findings indicate that banks and other private lenders view offshore operations as a credit risk-increasing factor, when lending to multinational firms that have subsidiaries in OFCs.
Keywords: offshore operation; offshore financial center; loan contracting; information risk; default risk; legal enforcement
JEL Classification: F34, F36, G15, G21, G32, K22
Suggested Citation: Suggested Citation