Bank Skin in the Game and Loan Contract Design: Evidence from Covenant-Lite Loans

Matthew T. Billett, Redouane Elkamhi, Latchezar Popov and Raunaq S. Pungaliya

Journal of Financial and Quantitative Analysis, 2016, vol. 51, issue 3, 839-873

Abstract: In a model of dual-agency problems where borrower–lender and bank–nonbank incentives may conflict, we predict a hockey stick relation between bank skin in the game and covenant tightness. As bank participation declines, covenant tightness increases until reaching a low threshold, at which point the relation sharply reverses and covenant protection is removed with a commensurate increase in spread. We find support for the hockey stick relation with bank’s stake in covenant-lite loans averaging 8% (0% median). We also find that covenant-lite loans are more likely when borrower moral hazard is less severe and when bank relationship rents are high.

Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:cup:jfinqa:v:51:y:2016:i:03:p:839-873_00

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