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

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

Research output: Contribution to journalArticle

3 Scopus citations

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.

Original languageEnglish
Pages (from-to)839-873
Number of pages35
JournalJournal of Financial and Quantitative Analysis
Volume51
Issue number3
DOIs
StatePublished - Jun 1 2016

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