Lending at Arm’s Length: How do Sovereign Ceiling Policies Really Matter for Corporate Borrowers?

Abstract

We examine the effect of firm credit rating downgrades on the pricing of syndicated bank loans following rating downgrades in the firms’ countries of domicile. We find that the sovereign ceiling policies used by credit rating agencies create a disproportionately adverse impact on the bounded firms’ borrowing costs relative to other domestic firms following their sovereign’s rating downgrade. We further show that information asymmetry between lenders and borrowers, as well as within the lending syndicate, constitutes an important mechanism through which the sovereign ceiling rule leads to higher loan spreads. However, we find that not all firms are equally penalized: relationship and cross-listed borrowers with subsidiaries in the lender’s country and borrowers operating in competitive industries are much less affected.

Keywords: Credit ratings, Sovereign ceiling, Bank credit, Relationship lending, Foreign-currency lending, Firm credit constraints

JEL Classification: F34, G21, G24, G28, G32, H63