Do Banks Care About Analysts' Forecasts When Designing Loan Contracts?

Journal of Business Finance and Accounting 45 (1-2): 1-26, 2017

49 Pages Posted: 14 Dec 2017 Last revised: 25 May 2021

See all articles by Joshua G. Coyne

Joshua G. Coyne

University of Central Arkansas

Derrald Stice

The University of Hong Kong - School of Business; HKU Business School, The University of Hong Kong

Date Written: November 17, 2017

Abstract

We investigate whether banks rely on the information content in equity analysts’ annual earnings forecasts when assessing the risk of potential borrowers. While a long literature finds that analysts provide useful information to market participants, it is not clear that banks, which have access to privileged information, would benefit from publicly available analysts’ forecasts. If, however, banks do rely on this information, then more precise private information in earnings forecasts may inform banks. We focus our analysis on the requirement of collateral because it is a direct measure of default risk, whereas other loan terms such as interest spread and debt covenants can also protect against other risks, such as asset misappropriation. The direct link between collateral and default risk allows us to examine whether information from analysts is relevant to banks when designing loan contracts. Consistent with our predictions, we find that higher precision of the private information in analysts’ earnings forecasts is associated with a lower likelihood of requiring collateral, and this effect is larger when a borrower does not have a prior relationship with the lender or their accounting or credit quality is low. We also find that this association disappears after the implementation of Regulation FD, consistent with this regulation reducing analysts’ access to private information.

Keywords: Equity Analysts, Earnings Forecasts, Bank Loans, Information Precision

JEL Classification: M41, G21

Suggested Citation

Coyne, Joshua G. and Stice, Derrald, Do Banks Care About Analysts' Forecasts When Designing Loan Contracts? (November 17, 2017). Journal of Business Finance and Accounting 45 (1-2): 1-26, 2017, Available at SSRN: https://ssrn.com/abstract=3086181 or http://dx.doi.org/10.2139/ssrn.3086181

Joshua G. Coyne (Contact Author)

University of Central Arkansas ( email )

201 Donaghey Ave.
Conway, AK 72035
United States

Derrald Stice

The University of Hong Kong - School of Business ( email )

Meng Wah Complex
Pokfulam Road
Hong Kong
China

HKU Business School, The University of Hong Kong ( email )

Hong Kong
China

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