Credit Supply and Contracting on Hard Information in Debt Markets

Abstract

We use fair value adoption as a quasi-natural experiment to examine the effect of hard information on credit supply through a contracting channel. After fair value adoption, usage of financial covenants depending on capital-based fair value treatments significantly declined. Capital-based covenant usage by treated borrowers in the financial sector dropped by 7.7% relative to control borrowers. They also experienced an 8.2% relative drop in credit supply, suggesting that the debt contracting space shrunk. Affected borrowers did not compensate with alternative funding sources; they decreased their own lending by 2.8%, propagating these contracting effects to the real economy.

Keywords: loan contracting, hard information, covenants, credit availability, real effects

JEL Classification: G21, G28, G32, M41