CEO inside debt and bank loan syndicate structure

• Published date: 01 September 2017
• Date: 01 September 2017
• DOI: http://doi.org/10.1016/j.rfe.2017.06.004

CEO inside debt and bank loan syndicate structure

Liqiang Chen

a,

⁎,HongFan

b

a

Departmentof Finance, IS & MS, SobeySchool of Business, SaintMary's University,Halifax, NS B3H 3C3, Canada

b

Departmentof Accounting, SobeySchool of Business, SaintMary's University,Halifax, NS B3H 3C3, Canada

abstractarticle info

Articlehistory:

Received26 November 2016

Receivedin revised form 8 June 2017

Accepted9 June 2017

Availableonline 15 June 2017

JEL classification:

G3

G21

G32

This paper investigatesthe effects of a borrowing firm's CEO insidedebt holdings on the structure of the firm's

syndicatedloans. When a borrowing firm's CEO has a higherlevel of inside debt holdings, syndicateloans have

a larger number of lendersand are less concentrated, and lead arrangers will retaina smaller portion of loans.

In addition, CEO inside debtholdings have a lesser effect on the syndicate structure when lead arrangershave

a prior lendingrelationship with the borrowing firm or the CEOs are closeto retirement, while CEO inside debt

holdings have greater influen ce on the syndicate structure when the borrowing firm ha s low information

transparency.

© 2017 Elsevier Inc. All rights reserved.

Keywords:

Executivecompensation

Insidedebt

Syndicateloans

1. Introduction

Syndicated loanshave become a dominant form of bank lending in

the global corporate financing ma rket, with originations surpassing

$4.2 trillion in 2013 accordingto Loan Pricing Corporation.

1

By defini-

tion, there are multiple lenders in a syndicated loan, with one ormore

of the lenders(lead arrangers/leadbanks) playing the role of arranging,

pricing and monitoring the loan. Althoughlead arrangers perform the

traditional role of due diligence as informedlenders, the loan amount

is shared with other syndicate members, and lead arrangers hol d

b100% of thedebt in a syndicate (Esty,2001). As a result,lead arrangers

may shirk their monitoringresponsibilities when undertaking mostof

the monitoring costs and owning only part of a loa n, and loans with

higher ex ante credit risks are less desired by lead ar rangers when

they have an information advantage ove r participant banks

(Holmstrom & Tirole, 1997; Sufi, 2007). Therefore,the syndication pro-

cess generatesan additional conflict of interestbetween lead arrangers

and participantbanks in addition to the typicalborrower moral hazard

problems between a borrowing firm and lending banks. Participant

banks' concerns regarding lead b anks' shirking their due diligence

duties could be especially relevan t when borrower moral hazard

problems are severe. Those concerns are reflected in the structure of

syndicatedloans during the syndicationprocess.

2

In this study, we focus on executive compensation with debt fea-

tures (“inside debt”) to explore how CEO ins ide debt holdings affect

the structure of syndicated loan s. Agency theory posits that inside

debt such as executive pension plans and/ or deferred compensation

can mitigate shareholder-cre ditor conflicts of interest (Jensen &

Meckling, 1976). Becauseinside debt obligations represent long-term,

unsecured,unfunded claims againstfirm assets and are payableat a fu-

ture date,the value of CEOs' inside debt holdingsis sensitive to both the

probability of bankruptcy and th e liquidation value.

3

In the event of

bankruptcy or insolvency, insid e debt holdings are at risk, and CEOs

face similar default risk as other outside cre ditors (Edmans & Liu,

2011; Sundaram & Yermack, 2007 ).As a result, greaterinside debt hold-

ings encourage CEOsto manage firms more conservatively with lower

Reviewof Financial Economics 34 (2017)74–85

⁎Correspondingauthor.

E-mailaddresses: liqiang.chen@smu.ca (L. Chen),hong.fan@smu.ca (H.Fan).

1

Loan PricingCorporation (LPC) of ThomsonReuters is the premier globalprovider of

information on the syndic ated loan markets. For additional informa tion, please visit

https://www.loanpricing.com/.

2

Forexample, Lin et al. (2012)find that borrowingfirms that have a greater divergence

between ownershiprights and cash flow rights have fewer participantbanks in a syndi-

cate, and the lead banks are asked to maintain a larger amount of loa ns. Chen (2014)

shows that borrowing firms withgreater CEO risk-takingincentives areusually associated

with a more concentratedsyndicate, and thelead arrangers are required to hold a larger

portionof the syndicate's loans.

3

Executivepension plans usually includetax-qualified plans that cover all employees

(rank-and-fileplans, RAFs), supplementalexecutive retirement plans (SERPs)and other

deferredcompensation(ODC). RAFs are requiredto be funded and securedunder the Em-

ployeeRetirement Income SecurityAct up to $200,000 annually.Both SERPs and ODCdo

not have to be funded or secured, and such schemes expose executives to risk of loss if

the firms enter bankruptcyor become insolvent. Please see Anantharaman et al. (2014)

for a detaileddiscussion.

http://dx.doi.org/10.1016/j.rfe.2017.06.004

1058-3300/©2017 Elsevier Inc. All rightsreserved.

Contents listsavailable at ScienceDirect

Review of Financial Economics

journal homepage: www.elsevier.com/locate/rfe