Are All Types of Real Transaction Management Equal in the Eyes of Bank Lenders?

Abstract

This study examines whether bank lenders have different reactions to various types of real transaction management (RTM) by borrowing firms. Drawing upon Jensen and Meckling’s asset substitution theory (1976) as well as banks’ unique payoff functions and monitoring incentives, we predict and find that banks offer more favorable loan terms (i.e., lower interest spreads, reduced probability for required collateral, reduced number and strictness of financial covenants) for firms displaying higher levels of RTM through reductions in R&D expenditures. In contrast, banks offer less favorable loan terms for firms displaying higher levels of RTM through aggressive price discounts, overproduction of inventories, and abnormal reduction of SG&A expenses. Additional analysis reveals that the favorable effect on loan pricing for R&D outlay reductions is smaller for longer-maturity loans. Overall, our study suggests that banks do not negatively view all forms of RTM.

Keywords: real transaction management; loan contracting; cost of debt; debt covenants; probability of debt covenant violation

JEL Classification: G14, M41, M43