Lock‐In Effects in Relationship Lending: Evidence from DIP Loans

Abstract

Do prior lending relationships result in pass-through savings (lower interest rates) for borrowers, or do they lock in higher costs for borrowers? Theoretical models suggest that when borrowers experience greater information asymmetry, higher switching costs, and limited access to capital markets, they become locked into higher costs from their existing lenders. Firms in Chapter 11 seeking debtor-in-possession (DIP) financing often fit this profile. We investigate the presence of lock-in effects using a sample of 348 DIP loans. We account for endogeneity using the instrument variable (IV) approach and the Heckman selection model and find consistent evidence that prior lending relationship is associated with higher interest costs and the effect is more severe for stronger existing relationships. Our study provides direct evidence that prior lending relationships do create a lock-in effect under certain circumstances, such as DIP financing.JEL codes: G21

Credit market concentration, relationship lending and the cost of debt

“…The borrowing firm has an incentive to provide this informational surplus to obtain funds at date zero, despite future rent extractions; thus borrowers prefer relationship lending. To provide empirical evidence in this regard, Hazan et al (2010) investigate lock-in effects in the market for "debtor in possession" (DIP) loans. DIP loans are extended by financial investors to firms that have filed for Chapter 11 bankruptcy protection to assist their reorganization.…”

Relationship Lending and Switching Costs under Asymmetric Information about Bank Types

“…Hence, our study provides the same result as the traditional models: the interest rate rises or declines during the relationship. In the introduction, we reviewed evidence that loan rates rise as the relationship matures (e.g., Petersen and Rajan 1995;Angelini et al 1998;Degryse and Van Cayseele 2000;Hernandez-Canovas and Martinez-Solano 2010;Ioannidou and Ongena 2010;Hasan et al 2019). By contrast, Berger and Udell (1995) and Bharath et al (2011) identify decreases in rates over time.…”