Debt Contracting When Borrowers Face Transitory Uncertainty: Evidence from U.S. Gubernatorial Elections

43 Pages Posted: 31 Jul 2019 Last revised: 2 Jul 2020

See all articles by Kirak Kim

Kirak Kim

University of Bristol - School of Economics Finance and Management

Trang Nguyen

University of Bristol - School of Economics, Finance and Management

Date Written: June 30, 2020

Abstract

We examine the impact of policy uncertainty surrounding U.S. gubernatorial elections on loan contracting outcomes. Loans made to firms headquartered in election states are more likely to include contingency-pricing provisions and financial covenants. The effect is pronounced for cash flow-based pricing grids and covenants---vis-à-vis balance sheet-based ones---and is stronger when elections are closely contested. Consistent with efficiency of loan contracting under transitory uncertainty, we find no direct effect on loan spreads. However, an important pricing effect is manifested through interest-rate contingencies in pricing grids. The use of rate-increasing grids increases significantly in election years for the firms with geographically concentrated operations and government contract-dependent ones. Our findings suggest that while the contingency-pricing feature curbs an explicit rise in the cost of loans for borrowers facing elections, loan contracts are designed to ensure compensation to lenders for uncertainty---via interest-rate contingencies---and to factor in increased monitoring demand.

Keywords: uncertainty, gubernatorial election, debt contract, contingency pricing, cost of capital

JEL Classification: G30, G39

Suggested Citation

Kim, Kirak and Nguyen, Trang, Debt Contracting When Borrowers Face Transitory Uncertainty: Evidence from U.S. Gubernatorial Elections (June 30, 2020). Available at SSRN: https://ssrn.com/abstract=3427141 or http://dx.doi.org/10.2139/ssrn.3427141

Kirak Kim (Contact Author)

University of Bristol - School of Economics Finance and Management ( email )

12 Priory Road
Bristol, BS8 1TU
United Kingdom

Trang Nguyen

University of Bristol - School of Economics, Finance and Management ( email )

United Kingdom

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