Loans to Chapter 11 Firms: Contract Design, Repayment Risk, and Pricing

54 Pages Posted: 16 May 2019 Last revised: 28 Nov 2022

See all articles by B. Espen Eckbo

B. Espen Eckbo

Tuck School of Business at Dartmouth; European Corporate Governance Institute (ECGI)

Kai Li

University of British Columbia (UBC) - Sauder School of Business; Asian Bureau of Finance and Economic Research (ABFER); China Academy of Financial Research (CAFR); European Corporate Governance Institute (ECGI); Canadian Sustainable Finance Network (CSFN)

Wei Wang

Queen's University - Smith School of Business

Date Written: November 27, 2022

Abstract

With a hand-collected set of 545 debtor-in-possession (DIP) loan facilities, 2002-2019, we show that these short-term loans are highly over-collateralized and contain a comprehensive set of restrictive covenants, mandatory prepayments, and restructuring milestones - all of which help produce a near-zero repayment risk. Nevertheless, the all-in spread drawn averages 658 basis points - almost five times the average spread on matched investment-grade loans, and nearly double the average spread on matched leveraged loans issued by highly risky firms outside of bankruptcy. Textual analysis of court documents shows lack of outside lender participation in the loan solicitation process but spreads are somewhat lower when outside interest is high. We discuss alternative interpretations of the high DIP-loan spreads, ranging from monitoring-cost compensation to rent extraction as DIP-loan providers with strong bargaining power share in the preservation of going-concern value helped by the `last resort' loan.

Keywords: debtor-in-possession financing, Chapter 11; loan spreads, loan fees, default risk, leveraged loans, relationship lending, rent extraction

JEL Classification: G14, G34

Suggested Citation

Eckbo, B. Espen and Li, Kai and Wang, Wei, Loans to Chapter 11 Firms: Contract Design, Repayment Risk, and Pricing (November 27, 2022). European Corporate Governance Institute – Finance Working Paper No. 794/2021, Journal of Law and Economics, forthcoming, Available at SSRN: https://ssrn.com/abstract=3384389 or http://dx.doi.org/10.2139/ssrn.3384389

B. Espen Eckbo

Tuck School of Business at Dartmouth ( email )

Hanover, NH 03755
United States
603-646-3953 (Phone)
603-646-3805 (Fax)

HOME PAGE: http://tuck.dartmouth.edu/faculty/faculty-directory/b-espen-eckbo

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Kai Li (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-822-8353 (Phone)
604-822-4695 (Fax)

HOME PAGE: http://https://sites.google.com/view/kaili/home

Asian Bureau of Finance and Economic Research (ABFER) ( email )

BIZ 2 Storey 4, 04-05
1 Business Link
Singapore, 117592
Singapore

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Canadian Sustainable Finance Network (CSFN) ( email )

Queens University
Kingston, ON
Canada

HOME PAGE: http://https://smith.queensu.ca/centres/isf/research/network.php

Wei Wang

Queen's University - Smith School of Business ( email )

Queen's University-Smith School of Business
143 Union Street
Kingston, Ontario K7L 3N6
Canada

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