Contracting Costs and Reputational Contracts
46 Pages Posted: 7 Jan 2021 Last revised: 21 Apr 2021
Date Written: March 18, 2021
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: Suggested Citation