Private Information and Bank-Loan Pricing: The Effect of Upcoming Corporate Spinoffs

Abstract

Corporate spinoffs are important events that are accompanied by valuation and credit-risk implications for the parent firm. Among other benefits, spinoffs can improve corporate focus and enhance valuation transparency. In the debt-contracting context, however, spinoffs can also be associated with negative outcomes for the divesting firms. We examine whether banks, due to their timely access to material private information, are able to ascertain the likelihood and the implications of impending spinoffs for the parent firm before a formal public announcement of the spinoff. Our empirical analyses indicate that, in the 365-day pre-spinoff announcement period, banks charge incrementally higher (lower) spreads to borrowers with increased (decreased) post-spinoff riskiness relative to non-divesting firms. This suggests that, while lenders recognize the value- and transparency-enhancing effects of spinoffs, they are also able to foresee potentially negative implications of these divestitures. Cross-sectional analyses indicate that banks charge incrementally lower loan spreads if spinoffs result in high-risk borrowers having either higher reporting quality or lower reporting or operational complexity. These results suggest that the post-spinoff increase in riskiness is compensated by the divestiture benefits typically associated with spinoffs. Similarly, high-risk borrowers incur larger spreads if they do not undergo “focus-increasing” spinoffs. Overall, our findings suggest that banks are able to ex-ante determine the implications of important corporate events such as spinoffs.

Keywords: Spinoffs, Bank-Loan Pricing, Private Information, Financial Reporting Quality, Disclosure, Complexity, Ex-Ante Analyses.

JEL Classification: G21, G30, G34, M10, M40, M41