Contracting Costs and Reputational Contracts

46 Pages Posted: 7 Jan 2021 Last revised: 21 Apr 2021

See all articles by Dominique C. Badoer

Dominique C. Badoer

University of Illinois at Chicago - Department of Finance

Mustafa Emin

University of Florida - Department of Finance, Insurance and Real Estate

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: March 18, 2021

Abstract

Reputational capital is a frequently cited attribute of private equity transactions. In this paper we construct a simple model to illustrate the relationship between reputational capital, covenants and loan spreads in the leveraged loan market. Our model predicts that reliance on reputational capital varies inversely with a sponsor’s past loan performance and the efficiency of the enforcement formal contracts terms. Our model also predicts that for sponsored deals, spreads will be lower on Cov-Lite loans than loans with maintenance covenants. Using a large sample of leveraged loans originated between 2005 and 2018, we find evidence consistent with these predictions.

Keywords: Cov-Lite Loans, Institutional Loans, Private Equity Firms, Reputational Contracting

JEL Classification: G21, G23, G29, G33

Suggested Citation

Badoer, Dominique C. and Emin, Mustafa and James, Christopher M., Contracting Costs and Reputational Contracts (March 18, 2021). Available at SSRN: https://ssrn.com/abstract=3536458 or http://dx.doi.org/10.2139/ssrn.3536458

Dominique C. Badoer (Contact Author)

University of Illinois at Chicago - Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States

Mustafa Emin

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

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