The Determinants of Contract Terms in Bank Revolving Credit Agreements

Abstract

The paper examines the determinants of contract terms on bank revolving credit agreements (revolvers) of mediudarge publicly traded companies. We model the duration (maturity), secured status, and pricing decisions within a simultaneous decision framework, thereby overcoming the biased and inconsistent estimates in prior single equation studies of debt contract terms. We find strong interrelationships between contract terms with significant bi-directional relationships between duration and secured status and between the all-in-spread and commitment fees and a unidirectional relationship from both duration and secured status to all-in-spread. We also illustrate how several single equation studies of contract terms draw incorrect conclusions because of their (inappropriate) assumption that other contract terms and leverage were exogenous. Finally, our results support the hypothesis that the setting of contract terms plays an important role in alleviating contracting problems.

Structure of Debt Maturity Across the Firm Type Spectrum

“…An insignificant estimate on the tax variable is consistent with the findings reported in Dennis, Nandy, and Sharpe (2000) and Scherr and Hulburt (2001) There are also studies which find a negative and significant coefficient estimate on the firm size variable; examples include Dennis, Nandy, and Sharpe (2000), Scherr and Hulburt (2001), and Heyman, Deloof, and Ooghe (2008). in the equation that includes Leverage. Although inconsistent with the tax perspective, this result indicates that firms avoid entering into long-term debt contracts when the degree of macroeconomic uncertainty is high.…”

The Determinants of Corporate Debt Maturity Structure

“…As presented above, only a system of simultaneous equations can represent these joint decisions as banks offer a number of loans from which the borrowers choose their desired contract features based on the loans' characteristics as well as their own ability to pay off the debt in the future (Dennis et al, 2000). Financial theory does not provide the appropriate restrictions allowing for such analysis although several studies have attempted to estimate this simultaneous equation framework (Dennis et al, 2000).…”

“…According to Dennis et al (2000), the employment of the reduced form of debt-maturity model estimated using OLS estimation yields unbiased results. There are several OLS estimation methods employed to estimate the relationship between debt maturity and its determinants.…”

“…Financial theory does not provide the appropriate restrictions allowing for such analysis although several studies have attempted to estimate this simultaneous equation framework (Dennis et al, 2000). As a result, the debt-maturity model is a reduced-form regression based on the simultaneous equations system Barclay & Smith, 1995).…”

The Effects of the Bank-Internal Ratings on the Loan Maturity

“…Dennis, Nandy and Sharpe (2000) focus on the effects of ratings on maturity of bank loans. However, instead of using internal bank ratings they account for the borrowers' credit quality only indirectly by using three proxies: However, the results for medium-risk, high-risk and extremely high-risk loans disagree with Diamonds' findings.…”