Soft Information in Loan Agreements

46 Pages Posted: 23 Dec 2016 Last revised: 1 Jun 2018

See all articles by Zahn Bozanic

Zahn Bozanic

Ohio State University (OSU) - Fisher College of Business

Lin Cheng

The University of Arizona - Eller College of Management

Tzachi Zach

Ohio State University (OSU) - Fisher College of Business

Date Written: December 22, 2016

Abstract

In this study, we seek to understand whether soft information conveyed by contracting language found in private loan agreements is informative regarding borrower risk. We proxy for credit-risk-relevant soft information using Loughran and McDonald’s (2011) uncertainty measure. We first examine initial contract terms and find that, incremental to traditional summary measures of credit risk, increased contractual uncertainty is associated with higher initial loan spreads and a greater likelihood of using dynamic and performance pricing covenants. We then turn to examine realized credit risk over the life of the loan and find that increased uncertainty is associated with a higher likelihood of future loan downgrades and loan amendments. We corroborate our results on the risk relevance of soft information by showing that the bid-ask spreads of loans trading on the secondary loan market are increasing in uncertainty. Overall, the evidence we provide is consistent with embedded linguistic cues in loan agreements publicly revealing the credit risk assessments of privately informed lenders.

Keywords: Soft information, loan agreements, contract language, borrower risk, credit risk, uncertainty

JEL Classification: D81, G32, M41

Suggested Citation

Bozanic, Zahn and Cheng, Lin and Zach, Tzachi, Soft Information in Loan Agreements (December 22, 2016). Journal of Accounting, Auditing and Finance, 2018, Vol. 33(1), 40-71. Available at SSRN: https://ssrn.com/abstract=2888876

Zahn Bozanic (Contact Author)

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

Lin Cheng

The University of Arizona - Eller College of Management ( email )

McClelland Hall, Room 301Q
1130 E. Helen Street
Tucson, AZ 85721
United States

Tzachi Zach

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-4101 (Phone)

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