Financial Institutions Network and the Certification Value of Bank Loans

• Date: 01 June 2018
• Published date: 01 June 2018
• Author: Christophe J. Godlewski,Bulat Sanditov
• DOI: http://doi.org/10.1111/fima.12197

Financial Institutions Network and the

Certification Value of Bank Loans

Christophe J. Godlewski and Bulat Sanditov∗

Social networks play an important role in mitigating informational frictions related to finan-

cial intermediation, especially bank lending. We investigate the effect of the network of financial

institutions on the certification value of bank loans using data on syndicated loans to Euro-

pean companies. We find that the presence of more central leaders in a syndicate substan-

tially increases the stock market’s reaction to loan announcements. This certification value is

reinforced when informational frictions are more important but vanishes when there are se-

vere disruptions in the functioning of financial markets, such as during the financial crisis of

2008.

Empirical evidencesuppor ts the viewthat bank loans bear a cer tification value, with positive and

significant abnormal returns for bor rowers’ stock around the date of a bank loan announcement

(James, 1987; Lummer and McConnell, 1989; Slovin, Johnson, and Glascock, 1992; Best and

Zhang, 1993; Preece and Mullineaux, 1996; Focarelli, Pozzolo, and Casolaro, 2008). This is

because banks are believed to produce valuable private information regarding a borrower’s risk

profile and quality (Diamond, 1984, 1991; Fama,1985), and screening and monitoring allow banks

to mitigate agency problems stemming from information asymmetries in the lender-borrower

relationship (Leland and Pyle, 1977; Diamond, 1984; Fama, 1985).

In the case of syndicated lending. which is the largest private bank debt market in the world

(US$4 trillion in 2016), financial institutions often rely on a lead bank’s informedness in making

lending decisions (Ross, 2010) because of their pivotal role in the transaction.1,2 Securing a

syndicated loan from a pool of banks led by well-informed leaders with an established track

record of deals signals the market about the quality of a borrower and a deal, thus mitigating

informational frictions and reducing agency costs (Johnson, 1997; Panyagometh and Roberts,

We are very grateful to the editor and an anonymous referee for valuable suggestions, and to Kentaro Asai, Patrick

McColgan, AndreeaPiloiu, and Tomas Vyrost for helpful comments, as well as to participants at the 2015 FrenchFinance

Association(Cergy), 2015 International Finance INFINITI (Ljubljana), 2015 Financial ManagementAssociation (Venice),

and 2015 European Financial Management Association (Breukelen) conferences for insightful discussions. The usual

disclaimer applies.

∗Christophe J.Godlewski is a Full Professor of CorporateFinance and Banking at Faculty of Law and Business, University

of Strasbourg,and a Professor of Finance at EM Strasbourg Business School in Strasbourg,France. Bulat Sanditov is an

Associate Professor of Economics at Telecom Ecole de Management, Institut Mines-Telecomin Paris, France.

1The benefits of loan syndication for both lenders (portfolio risk and sources of revenue diversification) and borrowers

(mostly lower costs as compared to bond issues or a series of bilateral loans) largely explainthe success of syndicated

lending.

2A loan syndicate comprises a lead bank (agent/arranger) that originates the loan and participant banks (or participants).

The lead bank is responsible for negotiating the key loan terms with the borrower, appointing the participants, and

structuring the syndicate. It is thus responsible for due diligence, allocation of the loan to other syndicate members, and

ex post monitoring. See Esty (2001) and Taylor and Sansone(2006) for a detailed presentation of the loan syndication

process.

Financial Management •Summer 2018 •pages 253 – 283

254 Financial Management rSummer 2018

2010; Gopalan, Nanda, and Yerramilli, 2011; Bushman and Wittenberg-Moerman, 2012; Gatti

et al., 2013).3

The ability of lenders to tap into information flows among parties is an important feature of

bank syndicates that has recently gained academic interest because of the potential mitigation

effects of agency costs. However, empirical evidence of the impact of a financial institution’s

network on a borrowing firm’s value and the certification effect of bank loans remains scarce.

Following the recent interest in social network analysis of the financial industry (Pistor, 2009;

Allen and Babus, 2010), the aim of this article is to investigate the effect of a lender’s network on

the certification value of bank debt.

The syndicated lending market bears several social network functions because it serves as an

information network that allows the lender to acquire private information on borrowers’ quality

and as a capital network that is used to raise of the necessary funding of loans (Baum, Shipilov,

and Rowley, 2003; Baum, Rowley, and Shipilov, 2004; Morrison and Wilhelm, 2007; Godlewski,

Sanditov, and Burger-Helmchen, 2012).4These two network functions address issues caused

by inherent information asymmetries at the two layers of relationships typical for such markets

by decreasing screening and monitoring costs at the borrower-lender level, and by creating

conditions for building trust and reputation at the arranger(s)-other participants of the syndicate

level.

By attaining a central position in such interorganizational networks, financial institutions can

get access to valuable private information that makes screening and monitoring activities less

costly and more efficient. Cohen, Frazzini, and Malloy (2008) show that mutual fund portfo-

lio managers place larger bets on firms with which they are connected through their personal

networks and perform significantly better on these holdings relative to their nonconnected hold-

ings. Cai and Sevilir (2012) examine the effect of board connections on merger and acquisition

(M&A) transactions and conclude that direct and indirect connections between acquirer and target

firms provide the former with an information advantage about the true value of the latter over

nonconnected, and therefore less informed, bidders.

Another important function of the social network is to provide conditions for building trust

among market participants and encourage investment in reputation capital. Repeated interactions

over time and tie embeddedness directly aim to solve problems of informational asymmetries

because they create trust and reciprocity (Chuluun, 2015). In the same vein, B¨

ulb¨

ul (2013) shows

that intense interaction with central coordinators supports trust building within a network. For

participants of the syndicated lending market, reputation is vital because it may become essential

in solving the moral hazard problem and curb-associated agency costs. Furthermore, one may

expect that banks occupying central positions in the information network are more sensitive to

reputation concerns than those at the network periphery because their interactions with their

partners are monitored by many market participants. At the same time, the apparent network

3Adverse selection problems may arise because, unlike arrangers, participants generally do not have direct lending

relationships with borrowers. The syndicate structure also weakens the arranger’s incentives to screen and monitor

borrowers because it holds only a portion of the loan, generating moral hazard problems. Other characteristics such as

syndicate size and concentration also have aninfluence on agency costs (Esty and Megginson, 2003; Lee and Mullineaux,

2004; Jones, Lang, and Nigro, 2005; Franc¸ois and Missonnier-Piera, 2007; Sufi, 2007; Focarelli et al., 2008; Godlewski,

2010; Bosch and Steffen, 2011).

4Morrison and Wilhelm (2007) emphasize this networkingfunction of f inancial intermediaries in capital markets, arguing

that a primary reason for investment banks to exist is their skills in creating and maintaining relevant networks.Similar

conclusions also apply to venture capital financing for which syndication is a mechanism to share complementary

knowledge and financial risks among partners (Sorenson and Stuart, 2001; De Clercq and Dimov, 2004; Casamatta and

Haritchabalet, 2007; Lerner, Cestone, and White, 2007; Tykvov´

a, 2007).