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The Real Effects of Debt Certification: Evidence from the Introduction of Bank Loan Ratings
Author(s): Amir Sufi
Source: The Review of Financial Studies, Vol. 22, No. 4 (Apr., 2009), pp. 1659-1691
Published by: Oxford University Press. Sponsor: The Society for Financial Studies.
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I thankDouglasDiamond,MichaelFaulkender,
AtifMian,TobiasMoskowitz,
Francisco
Anil
Perez-Gonzalez,
MitchellPetersen,
JoshuaRauh,MichaelRoberts,
MortenSorensen,
Saunders,
Kashyap,
Anthony
PhilipStrahan,
andseminarparticipants
at the University
of Virginia(McIntire),
the University
of Illinois,the University
of
the FRBNY/Wharton/RFS
conferenceon theCorporate
Finance
ChicagoGSB,the NBERSummerInstitute,
of FinancialIntermediaries,
Standard
& Poor's,andtheAmerican
I
forhelpfulcomments.
FinanceAssociation
alsothankMichaelWeisbach
refereesforsuggestions
thatimproved
thearticle.
(theeditor)andtwoanonymous
JasonLauprovided
excellentresearch
assistance.
Sendcorrespondence
to A. Sufi,Graduate
Schoolof Business,
of Chicago,5807SouthWoodlawn
Avenue,Chicago,IL60637.E-mail:amir.sufi@chicagogsb.edu.
University
O The Author2007. Publishedby OxfordUniversityPresson behalfof TheSocietyfor FinancialStudies.
All rights reserved.For Permissions,please e-mail:journals.permissions@oxfordjournals.org.
doi: 10.1093/rfs/hhm061
Advance Access publicationDecember 11, 2007
0.9
0.5
0. -3 ........
- - - --.-
0.14
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-
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--
........................ .............. ... .. .... .............. ... ..... ......... ..... ... ......... .... .. ...
.
0.1
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Year
-
Fraction
- -- -Asset weightedfraction
Figure1
Fractionof firmsthatever obtaina loan ratingby year.The sample includes all publicly listed firmsthatexist in
1994 through 1996.
and helps explainwhy bankstypically hold partof the loans they originate(see
Sufi, 2007). Unlike a bank, a third-partyratingagency does not hold the debt
of the borrowersthey certify, and relies on reputationalone when providing
certificationservices. The key empiricalquestion I seek to answer is the following: can a third-partyratingagency improvethe allocation of credit in the
economy withoutholding the debt they certify? Despite the increasingimportance of third-partyratingagencies bothin the US and worldwide,thereis little
empiricalresearchthat addressesthis question.
I attemptto bridge this gap in the existing researchby analyzing the introduction of syndicatedbank loan ratings by Moody's and S&P in 1995. S&P
states on theirWeb site thatloan ratingshelp borrowers".. . as ratings(1) help
to expanda loan's initial investorbase and secondary-marketliquidity;and (2)
facilitatepurchaseby institutionalinvestors,CDOs, specializedloan funds,and
otherbuyersthatneed ratingsor do not have large internalcredit staffs"(S&P,
2005). Loan ratingsprovideinformationto potentialsyndicatepartnersduring
the syndication process, and they provide informationto secondary market
participantsafterthe loan is originated.
I focus on the introductionof loan ratingsto assess the impactof third-party
debt certificationon financialandrealoutcomesof borrowers.The introduction
of loan ratingsoffers a promisingenvironmentfor two reasons.First,the scope
of the programis large. As Figure 1 demonstrates,by 2004, almost 30% of
public firms that existed in 1995 had obtaineda loan ratingand over 70% of
asset-weighted public firms had obtained a loan rating. Second, loan ratings
were unavailableto all firmsbefore 1995, andimmediatelybecame availableto
all firmsthereafter.Giventhatfirmswere restrictedfrom obtainingloan ratings
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Moody's and S&P began offering syndicated loan ratings to help expand
the initial base of investors during the syndicationprocess and to encourage
secondarymarketliquidity.Anecdotal evidence suggests that the introduction
of loan ratings was driven primarilyby the desire of nonbank institutional
investorsto participatein the market.As Bavaria(2002, p. 3) notes,
These [nonbankinstitutional]investors,madeup primarilyof retailmutual
funds (primarilyso-called"primerate"funds),specializedloan investment
vehicles (CDOs and similarentities),andtraditionalinstitutionalinvestors
like insurancecompanies,andothermoneymanagerswho havediscovered
the loan asset class, are accustomedto, and take for granted,the existence
of the traditionalsecurities marketinfrastructure.They must have thirdparty research... This has provided a powerful demand for ratings on
syndicatedloans that are targetedfor distributionto these entitities.
In addition, an American Banker (1996, p. 17) article' reportsthat "The increase [in the prevalenceof bankloan ratings]underscoreseffortsby commercial banks and their corporatecustomers to cater to the growing number of
institutionalinvestorswho want a piece of the bank loan syndicationmarket.
Standard& Poor's ratings ... are used by the investorcommunityto evaluate
debt."The fact that nonbankinstitutionalinvestorshelped spurthe creationof
syndicatedloan ratingshelps supportthe notion that the introductionof loan
ratingswas supply-driven.While many anecdotes suggest that ratingagencies
introducedloan ratingsas a responseto increasedwillingness to supplyfinancing by institutionalinvestors,there is little evidence that loan ratings were a
response to increasedborrowerdemandfor financing.
The evidence suggests that less-informedinvestorsdemandcertificationof
a third-partyratingagency in the syndicatedloan marketgiven the importance
of informationasymmetrybetweenthe lead arrangerandparticipantlendersin
the original syndication,and between banks and institutionalinvestors in the
secondarymarket.As noted earlier,a large body of empiricalresearchon syndicatedloans documentsthe problemsassociatedwith informationasymmetry
in this market.The ratingagencies claim that a loan ratingcan help to reduce
these problems:
[Ratings]are most useful when obtainedbefore the loan is syndicated,to
allow syndicatorsand investorsto incorporateourratingand analysis into
their pricing, distribution,and due-diligence decisions' (Bavaria,2004,
p. 2).
A borrowerwithout a previous security rated by the rating agency goes
through a two-step rating process.2 First, a borroweris assigned an issuer
credit rating,which measuresthe purerisk of default,andfocuses solely on the
I thankan anonymousrefereefor pointingme to this article.
2 This process describesS&P's
ratingprocedure.Moody's procedureis similar.
1665
overall creditworthinessof the issuer. Second, the loan rating focuses on both
the riskof defaultandthe likelihoodof ultimaterecoveryin the eventof default.
The loan ratingcontains informationabout the loan terms that is not revealed
in the issuer credit rating;as Bavaria(2005, p. 23) notes, "in assigning a loan
rating,Standard& Poor's creditanalystslook to see whetherthereis collateral
security or otherenhancementthat would enable investorsto achieve ultimate
recoveryif the loan defaults."A loan ratingcan be "notched"up-that is, given
a higher ratingthan the issuer credit rating-if holders of the syndicatedloan
can expect 100%recoveryratesin case of default.3
The borrowerdecides whether or not to obtain a rating during the syndication process. An importantelement in understandingwhether a firm obtains a loan rating is the fee schedule. The fee schedule for Moody's and
S&P is quite similar; I describe the S&P fee schedule for brevity. S&P
charges a transactionfee of 2.9 basis points for the first $1 billion of a
loan with maturityof one year or more, and 1.45 basis points for the amount
above $1 billion. For short-termfacilities of 364 days or less, the transaction
fee is 1 basis point for the first $1 billion, and 0.5 basis points thereafter.In
addition,a borrowerwith no previousissuer credit ratingfrom S&P must pay
an initial $50,000 fee. Finally, any borrowerwith an issuer credit ratingmust
pay a $39,000 annualfee to maintainthe rating.
A finalnote concernswhetherfirmschoose to obtaina loan rating,or whether
the loan ratingagency assigns a ratingregardlessof a requestby the firm.When
loan ratings were introduced,S&P provided them only at the request of the
borrower,whereas Moody's sometimes rated loans regardlessof whether a
borrowerrequestedthe rating (AmericanBanker, 1996). As I discuss below,
the most problematicidentificationissue is that borrowerschoose to obtain a
loan rating, and this choice may be correlatedwith increasesin unobservable
investmentdemand.Given thata ratingagency most likely has less information
on the unobservableinvestmentopportunitiesof the borrowerthanthe borrower
itself, it is beneficialin terms of identificationif ratingagencies assigned loan
ratings without the borrower'spermission. Regardless, all results presented
below are robustto the complete exclusion of loans ratedonly by Moody's.
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TheReviewof FinancialStudies/
v22 n 4 2009
1668
existing loan that increased the amount in the same fiscal year that the loan
rating is obtained.An examinationof the 10-K filings reveals that 213 of the
334 borrowersobtainan identifiablenew loan or an increasein the existing loan
in the same fiscal year as the loan ratingis obtained.I then searchfor all loans
by these borrowersin Dealscan from 1990 up to and including the first rated
loan.5I am able to find loans for 161 of the 213 borrowers.I include only loans
to borrowerswho have Compustatdata available, and only loans made from
1990 to 1998. The final sample includes 508 deals for these 161 borrowers.
1.2.2 Issuer credit ratings and bank loan ratings. An importantdataclarificationissue concerns the difference between issuer credit ratings and
bankloan ratings,and how they arerelated.Compustatitem 280 representsthe
issuercreditratingof a borrower,which is S&P's opinionof the issuer'soverall
creditworthiness.S&P provides an issuer credit ratingfor every borrowerfor
which it ratesany security,regardlessof whetherthe securityis registeredwith
the SEC. As mentionedabove, when S&P assigns a new loan rating,they also
assign an issuer credit rating.Consistentwith this practice,almost 90% of the
firms in the sample that do not have an issuer credit ratingbefore they obtain
a loan ratingfrom S&P subsequentlyobtainan issuer creditratingin the same
year they obtainthe loan rating.In otherwords, item 280 becomes nonmissing
in the same year as a firm obtainsa loan rating.
Extant researchuses the existence of item 280 as a proxy for whetherthe
firmhas outstandingpublic debt (Faulkenderand Petersen,2006; Cantilloand
Wright, 2000). Before 1995, this proxy is accurategiven that S&P primarily
rated instrumentsthat were registeredwith the SEC. However, as the above
informationsuggests,afterthe introductionof loanratingsin 1995, the existence
of item 280 is no longer an accurateproxy for whetherthe firmhas outstanding
public debt. A firmthatobtainsa loan ratingalso obtainsan issuer creditrating
even if the firm does not issue public debt.6 After 1995, if a firm obtains an
issuer credit ratingwithout having obtaineda loan rating,it has likely issued
publicly registereddebt securitiesduringthe fiscal year.
Throughoutthis article,I follow the extantliteratureand classify firms with
an issuer creditratingbefore 1995 as firmswith outstandingpublic debt. After
1995, I classify a firm as having outstandingpublic debt if the firm obtains an
issuer creditratingwithouthaving obtaineda loan rating.
1.2.3 Summary statistics. Figure 1 plots the increasein the fractionof firms
thatobtaina bankloan ratingfrom 1995 through2004. The rise is mostdramatic
from 1995 through1998, when the fractionof firmsrises from0 to almost20%.
By the end of 2004, almost 30%of firmshave obtaineda bankloan rating.The
5 In unreportedrobustnessanalyses, I have found similarresultswhen isolating the sample to 1994 through 1998.
6 Examplesof firmsthatobtainan issuer creditrating(andloan rating)butdo not issue new publicdebt are Stryker
Corpin 1998, Arch Coal in 1998, and Kennametalin 1998.
1669
250
200
150
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
SAll firms
01Firmswithno issuercreditratingrating
E3Firmswithissuercreditrating
Figure 2
Numberof firms that obtain their initial bank loan ratingby year and by whetherthe firm has an issuer credit
ratingas of 1994.
rise in the asset-weighted fraction of firms with a bank loan rating is even
more dramatic.From 1995 to 1998, the asset-weightedfractionof firms that
obtaineda bankloan ratingwent from 0 to 50%. By the end of 2004, over 70%
of the assets of public firmsin the sampleobtaineda bankloan rating.Figure 1
demonstratesthat bank loan ratingsare an importantelement in the corporate
financedecisions of a largenumberof US firms.In addition,the sharpincrease
in the numberof firmsobtainingloan ratingsshortlyaftertheirintroductionis
promisingin orderto identifythe causaleffect of loanratingson firmoutcomes.
Figure 2 plots by year the numberof firms that obtainedtheir initial bank
loan rating. It also splits firms by their issuer credit rating status as of 1994,
which is measuredusing whetherCompustatitem 280 is availablein 1994 for
the firm.The evidence suggests a sharprise in the numberof firmsadoptingthe
bank loan ratingtechnology in 1995 through 1997. By 1998 and 1999, fewer
firmsobtainedan initialbankloan rating,andeven fewer firmsobtaineda rating
each year after 1999. Like Figure 1, Figure 2 suggests that the main impact
of bank loan ratingsis realized in the years directly after their introductionin
1995. Figure 2 also suggests that both unratedand rated borrowersobtained
loan ratingsin almost equal proportion.
Table 1 presentssummarystatistics for the unbalancedpanel of 3407 firms
from 1990 to 1998 (25,538 firm-yearobservations).Overall, 15%of the firms
that are ever in the sample obtain a bank loan rating from Moody's, S&P,
or both by 1998. Slightly more firms obtained their initial bank loan rating
from Moody's than S&P (7.0% versus 5.4%). About 3% of firms obtained
initial bank loan ratingsfrom both Moody's and S&P in the same quarter.The
majorityof firmsobtainedtheirinitial bankloan ratingfrom eitherMoody's or
S&P, which underscoresthe importanceof using data from both of the rating
1670
Table1
Summarystatistics
Mean
Standarddeviation
0.154
0.070
0.054
0.029
0.069
0.085
0.049
0.361
0.169
0.225
0.256
0.253
0.278
0.215
Summarystatistics
Mean
Median
Standarddeviation
678
1.478
4.475
0.284
300
1.000
5.000
0.216
1,590
0.853
0.957
0.241
Full sample
Total assets ($M)
Sales ($M)
Firmage (years since IPO)
Book debt to assets
Market-to-bookratio (Q)
Tangibleassets to total assets
EBITDA/totalassets
Cash flow/assetst
Advertise/assets
R&D/assets
1,547
1,364
17
0.241
1.896
0.334
0.093
0.062
0.009
0.083
142
160
12
0.219
1.392
0.272
0.124
0.091
0.000
0.000
7,802
5,457
13
0.208
1.544
0.240
0.180
0.188
0.024
0.346
Outcomes
Asset growth
Capitalexpenditures/assets,1
Cash acquisitions/assets,_I
Change in NWC/assets,_
0.151
0.080
0.027
0.018
0.068
0.055
0.000
0.008
0.388
0.083
0.087
0.103
This table contains summarystatistics for an unbalancedpanel of 3407 firms from 1990 through 1998 (25,538
firm-years).
1671
2. TheoreticalFramework
How shouldthe introductionof bankloanratingsaffectfirms?Inorderto answer
this question,I develop a theoreticalframeworkthat is motivatedby the model
of HolmstromandTirole(1997). In theirframework,therearethreeparticipants
in debt markets:firms, informedlenders, and uninformedlenders. There is a
moralhazardproblemat the firmlevel given the existence of a projectwith large
privatebenefits(the "bad"project).In the absenceof a monitorthatcan prevent
the firm from taking on the bad project, uninformedlenders will not lend to
the borrower.Informedlendersexert monitoringeffort, which enables them to
prevent firms from taking on the bad project. However, effort exerted by the
informedlender is costly and unobservable.The unobservabilityof informed
lendereffort is a crucialfeatureof the model. Given thateffort of the informed
lendercannotbe contractedupon, informedlendersare forced to commit their
own capital to the project. Only a lender with a stake in the firm's project
can credibly commit to exertingthe necessary monitoringeffort. Uninformed
lenders commit funds to firms only after an informed lender has made the
commitmentto monitorby investingin the project.Informedlender capitalis
thereforea crucialelement of the ability of firmsto invest. As Holmstromand
Tirole (1997, p. 669) note, "Moralhazardforces intermediariesto inject some
of theirown capitalinto firmsthatthey monitor,makingthe aggregateamount
of intermediary(or 'informed')capital ... one of the importantconstraintson
aggregateinvestment."
I informallyextend this frameworkto analyze how the introductionof loan
ratingsaffects borrowers.First,I assume thatthe duties of the informedlender
can be split into two different functions, both of which involve costs. The
first function is certification.The certificationfunction involves certifying the
reputationof the borrowerand evaluatingthe projectbeing undertaken.In the
context of a syndicatedloan, certificationalso involves evaluatingcollateral,
relaying the existing debt structureof the firm to potential participants,and
determiningthe interestrate and fees. Certificationcan take place both before
the loan is originatedand afterwardsthroughupdatinginformationon default
risk.The second functionis monitoring.The monitoringfunctioninvolvesmore
direct managementof the firm's project.Examples include deciding whether
to enforce or waive a violation of a financial covenant, seizing or changing
collateral,or disallowing continuationof projectsprogressingpoorly.
The second assumptionI makeis thatthe introductionof a third-partyratings
technology reduces the total cost of certificationborne by the borrower.In
other words, a loan rating by Moody's or S&P provides certificationfor the
borrowerat a cheapercost thancertificationby the lead arrangeralone. While
the empirical analysis does not attempt to discern why Moody's and S&P
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Table2
Whoobtainsa bankloanrating?
Firmclassification
Totalassets ($M)
Sales ($M)
Firmage (years since IPO)
Market-to-bookratio(Q)
Book debt to assets
Tangibleassets to total assets
EBITDA/totalassets
(1)
Obtainsloan
ratingand has
no public debt
(N = 234)
(2)
Does not obtain
loan ratingand
has no public debt
(N = 2495)
(3)
Obtainsloan
ratingand has
public debt
(N = 289)
(4)
Does not obtain
loan ratingand
has public debt
(N = 389)
897
796
15
1.709
0.277
0.365
0.139
230*
222*
12*
1.969*
0.189*
0.293*
0.066*
5769*
4839*
27*
1.456*
0.350*
0.430*
0.140
4784*
4267*
27*
1.513*
0.324*
0.461*
0.134
This table presents 1994 mean characteristicsof firmsby whetherthey obtain a loan ratingsubsequentto 1995
and whetherthey have public debt as of 1994. Whethera firmhas public debt in 1994 is measuredby whether
the firm has an S&P issuer credit ratingas of 1994 (Compustatitem 280). * indicatesstatisticallydistinct from
column I at the 5% level.
This leads to a lower total certificationcost, allowing more capital from uninformed investorsand thus a higher investmentrate. Therefore,the framework
suggests that increasedborrowerinvestmentas a result of debt certificationis
financedprimarilyby less-informedlenders.
1674
Table 3
Comparing firms in year before obtaining loan rating to firms in year before obtaining public debt
Totalassets ($M)
Total sales ($M)
Firmage (years since IPO)
(1)
Yearbefore obtaining
loan rating
(N = 193)
(2)
Yearbefore initially
obtainingpublic debt
priorto 1995 (N = 188)
(3)
Yearbefore initially
obtainingpublic debt
1995 or after (N = 181)
1228
1061
15
1992*
1540*
16
1776
1561*
17
This table comparesthe size and age of firmsin the year beforeobtaininga loan rating(conditionalon not having
public debt) and the year before obtainingpublic debt. Before 1995, the year a firm initially obtains public debt
is the year it obtains an issuer creditrating.For 1995 and after,the year a firminitially obtainspublic debt is the
year it obtains an issuer credit rating without having previously or concurrentlyobtained a loan rating. Assets
and sales are measuredin 2000 dollars. * indicatesstatisticallydistinctfrom column I at the 5% level.
1675
4. BankLoanRatings,Leverage,and Investment
4.1 Empiricalmethodology
The theoretical frameworkhypothesizes that the introductionof bank loan
ratingsreducesthe cost of debt certificationand increasesthe pool of investors
willing to provide financingto borrowers.As a result, firms are able to raise
additionaldebt financingand increaseinvestment.The empiricalmethodology
in this section seeks to identify the causal impact of bank loan ratingson the
use of debt financingand on investment.
In order to describe the empirical methodology,I begin by describing the
ideal experimentalenvironment.The ideal experimentalenvironmentinvolves
randomassignmentof bank loan ratingsto firms.If loan ratingsare randomly
assigned to firms,then the specificationthatestimatesthe causal effect of bank
loan ratingson outcome y for a firmi is a basic linearregression:
yi = ot+
Px
LoanRatei+ Ei.
(1)
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Yit=
CE
t=1991
(2)
i=l
1677
also use an implied junk ratingbased on lagged firm characteristics(firm size and firm EBITDA scaled by
assets) with qualitativelysimilarresults(unreported).
1678
Table 4
The effect of obtaining a bank loan rating on availability of debt
Dependentvariable
(A debt/laggedassets)i,
(1)
(2)
(3)
Loan ratingi,
0.046**
(0.017)
0.043**
(0.017)
0.159**
(0.032)
0.186**
(0.031)
Loan ratingit,*Unratedi.
1994*Loan
junk ratedi,
Market-to-bookratioi,t-1
Tangibleassets to total assetsi,t_-I
In(totalassetsi,t_-I)
EBITDA/totalassetsi.t-_
Advertising/totalassetsi,_1
R&D/totalassetsi,_-I
R2
Numberof firms
Numberof firm-years
0.09
3,407
25,001
-0.002
(0.009)
0.012**
(0.002)
-0.004
(0.028)
-0.061**
(0.005)
0.107**
(0.018)
0.173
(0.113)
0.022*
(0.009)
0.035*
(0.017)
0.019
(0.036)
0.043
(0.041)
0.198**
(0.061)
0.012**
(0.002)
-0.005
(0.028)
-0.062**
(0.005)
0.109**
(0.018)
0.170
(0.112)
0.022*
(0.009)
0.12
3,407
25,001
0.12
3,407
25,001
0.70
3,407
25,001
(4)
0.121**
(0.017)
0.002
(0.009)
-0.003
(0.002)
0.220*
(0.023)
0.031**
(0.005)
-0.152**
(0.019)
0.018
(0.122)
-0.022**
(0.009)
0.006
(0.009)
-0.009
(0.018)
0.018
(0.017)
0.130**
(0.030)
-0.003
(0.002)
0.219*
(0.023)
0.031**
(0.005)
-0.152**
(0.019)
0.015
(0.122)
-0.022**
(0.009)
0.72
3,407
25,001
0.72
3,407
25,001
0.105**
(0.017)
This table presentscoefficient estimatesfrom firmfixed effects regressionsrelatingdebt at firmi in year t to the
existence of a bankloan ratingfor firmi in year t. The dependentvariablein columns 1 through3 is the change
in debt levels from t - 1 to t scaled by the book value of assets at t - 1, and the dependentvariablein columns
4 through 6 is the book debt to assets ratio. All regressions include year indicator variables interactedwith
two-digit SIC industrycodes. Standarderrorsare clusteredat the firmlevel. * Coefficientestimateis statistically
distinct from 0 at the 5 and 1%levels, respectively.
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Table5
Loandealsummarystatistics
Mean
Median
Standarddeviation
212
1.547
0.512
161
6.541
4.037
2.252
0.248
0.252
109
1.000
0.000
134
4.000
3.000
1.000
0.000
0.200
336
0.906
0.810
113
7.633
3.819
3.871
1.169
0.274
This table presents summarystatistics on loan deals obtained by borrowerswho do not have an issuer credit
ratingas of 1994, and subsequentlyobtaina loan ratingin 1995 or after.The sample includesonly borrowersfor
whom the first ratedloan is ratedat origination,only borrowerswhom I am able to matchto LPC's Dealscan,
and only borrowersfor whom lagged book debt, marketto book ratio,EBITDA,tangibleassets, and total assets
from Compustatare nonmissing.The sample includes 508 loan deals by 161 borrowers,and the loan deals are
originatedbetween 1990 and 1998. A domestic bank is any domestic commercialbank, finance company,or
investmentbank.
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As Table 5 shows, domestic banks are the most common type of lenders in
this market,with an average of 4.0 domestic banks in the syndicate.Foreign
banksrepresenton average2.3 lendersin syndicates,and nonbankinstitutional
investors represent only 0.25 lenders. These averages demonstratethat the
syndicatedloan marketis primarilya marketin which banks with specialized
monitoringand screeningskills participate.
The results presentedin Table 6 describehow a firm's firstratedloan compares to its previous unratedloans. Each cell in Table 6 reportsa coefficient
estimate from a separateregression;more specifically, each cell provides the
coefficient estimate on an indicatorvariablethat is equal to one if the loan is
rated. Column 1 reportsfirm fixed effects coefficient estimates, and Column
2 reports first difference estimates. All specifications include year indicator
variablesand control for the firm's lagged book debt ratio, EBITDA to assets
ratio, tangible assets ratio, the market-to-bookratio, and the naturallogarithm
of total assets. As the first row demonstrates,there is a large increase in the
loan amountwhen the borrowerobtainsa loan rating.The fixed effects estimate
implies a 70% increasein the size of the loan, and the first differenceestimate
implies a 47% increase. This finding is consistent with evidence presentedin
the previous section that borrowersexperience large increases in debt in the
year they obtain a loan rating.The increase in the size of the loan is drivenin
partby an increasein the numberof loan trancheson a given deal. In particular,
there is a significantincrease in the presence of term loan trancheson a firm's
first rated loan. Although the loan size increases by almost 70%, the interest
rate spreaddoes not show a statisticallysignificantchange.
Rows 5 through11 of Table6 provideevidence thatthe syndicatecomposition shifts towardless-informedlenderswhen firmsobtainloan ratings.In row
5, the coefficient estimate of the effect of a ratingon the numberof lenders is
5.8 in the fixed effects specification,and4.5 in the firstdifferencespecification.
Moreover,rows 7 and 8 show that between 50 and 60% of the increasein the
numberof lenders representsincreases in foreign bank and nonbankinstitutional investorparticipation.Row 9 shows thatthereis a statisticallysignificant
increase in the fractionof uninformedlenders in the syndicate,where the first
differencecoefficient estimateis significantat the 10%level. The fixed effects
coefficient estimates in rows 10 and 11 imply that a foreign bank or nonbank
institutionalinvestors is 26 and 16% more likely to be on the first rated loan
syndicate,relativeto previousloans by the same firm.
The evidence in Table 6 suggests that loan ratings increase the pool of
investors that are willing to hold part of a syndicatedloan. In particular,the
results suggest thatborrowersgain increasedaccess to less-informedinvestors,
such as foreign banks and nonbankinstitutionalinvestors.13
13 Table 5 also implies a simultaneousincrease in the numberof term loan tranchesand
the numberof nonbank
institutionalinvestors when a loan is rated. This evidence supportsthe model by Kashyap, Rajan, and Stein
(2002), which hypothesizes that commercial banks funded by deposits will specialize in lending via lines of
1681
Table 6
The effect of a loan rating on loan characteristics and syndicate composition
Specificationtype
Dependentvariable
(1)
In(loanamount)
(2)
(3)
(4)
Interestratespread(bp + LIBOR)
(5)
(6)
(7)
(8)
Numberof institutionalinvestors
(9)
Fractionof uninformedlenders
(10)
(11)
Indicatorfor institutionalinvestor
(1)
Fixed effects
Loan rated
0.698**
(0.155)
0.606**
(0.196)
0.442*
(0.174)
12
(15)
5.796**
(1.370)
2.579**
(0.666)
2.428**
(0.695)
0.771*
(0.328)
0.119**
(0.042)
0.260**
(0.077)
0.163**
(0.056)
(2)
Firstdifferences
Loan rated
0.469**
(0.166)
0.468**
(0.175)
0.305
(0.161)
7
(18)
4.454**
(1.300)
2.036**
(0.609)
1.715**
(0.688)
0.684**
(0.234)
0.076
(0.046)
0.212**
(0.079)
0.133*
(0.056)
1682
Table7
Theeffectof obtaininga bankloanratingon realoutcomes
Panel A
(1)
(2)
Asset growthit
(3)
(4)
0.078*
(0.031)
0.058
(0.030)
0.007
(0.004)
0.002
(0.007)
0.196**
(0.061)
0.230**
(0.058)
Dependentvariable
Loan ratingit,
0.111**
0.058
(0.033)
-0.002
(0.062)
0.064
(0.081)
0.239*
(0.116)
0.111**
0.012**
0.007
(0.004)
-0.008
(0.008)
-0.004
(0.007)
0.019
(0.012)
0.012**
(0.005)
(0.005)
(0.001)
(0.001)
0.536**
(0.052)
-0.208**
(0.048)
-0.332**
(0.042)
0.24
3,407
25,001
0.536**
(0.052)
-0.208**
(0.048)
-0.333**
(0.042)
0.24
3,407
25,001
0.028**
(0.006)
0.022**
(0.006)
-0.065**
(0.007)
0.56
3,388
24,646
0.028**
(0.006)
0.022**
(0.006)
-0.065**
(0.007)
0.56
3,388
24,646
R2
Numberof firms
Numberof firm-years
0.13
3,407
25,001
(7)
Panel B
(8)
Acqit/Assetsi,t-1
0.014
(0.009)
0.067**
(0.018)
0.012
(0.009
0.071**
(0.018)
Dependentvariable
Loan ratingit
Loan ratingi,*Loanjunk ratedi,
Loan ratingi,*Unratedi,
1994
Loan ratingit*Unratedi,1994*
Loanjunk ratedi,
0.005**
(0.001)
0.006
(0.009)
0.014
Qi,,t-1
Cash flowit/totalassetsi,tl
(EBITDA/totalassets)i,t-
(0.008)
(Book debt/totalassets)i,,_
RNumber
Numberof firm-years
Number
of
firm-years
0.19
3,397
23,855
(5)
(6)
CapExit/Assetsi,t-1
-0.075**
(0.008)
0.20
3,397
23,855
(9)
0.015
(0.010)
-0.006
(0.019)
0.004
(0.023)
0.100**
(0.035)
0.005**
(0.001)
0.007
(0.009)
0.014
0.007
(0.006)
0.53
3,388
24,646
(10)
(11)
(12)
A Net workingcapitalit/Assetsi,,-1
0.001
(0.006)
0.013
(0.010)
-0.003
(0.006)
0.020*
(0.010)
0.014**
(0.001)
0.244**
(0.013)
-0.067**
(0.008)
-0.076**
(0.008)
0.20
3,397
23,855
0.004
(0.004)
(0.013)
0.07
3,325
24,227
-0.079**
(0.011)
0.17
3,325
24,227
-0.007
(0.006)
0.008
(0.012)
0.006
(0.015)
0.016
(0.020)
0.014**
(0.001)
0.244**
(0.013)
-0.067**
(0.013)
-0.079**
(0.011)
0.17
3,325
24,227
This table presents coefficient estimates from firm fixed effects regressions relating real outcomes at firm i
in year t to the existence of a loan rating for firm i in year t. Columns I through 3 relate asset growth at
time t ([A, -A, _-1]/At-1), columns 4 through 6 relate capital expendituresat t scaled by assets at t- 1,
columns 7 through9 relate cash acquisitions at t scaled by assets at t - 1, and columns 10 through 12 relate
the change in net working capital at time t scaled by assets at t - 1 to the existence of a loan rating at t. All
regressions include year indicatorvariablesinteractedwith two-digit SIC industrycodes; standarderrorsare
clusteredat the firmlevel. *,**indicatecoefficient estimateis statisticallydistinctfrom 0 at the 5 and 1%levels,
respectively.
1683
1684
Table8
Obtainingloanrating,issuercreditrating,andunratedloan
(1)
(2)
(3)
(4)
Debtto
Asset
(A Debt/
Acqit/
Laggedassets)i, assetsratioi,
growthit
Assetsi,t1_
PanelA: Obtainingloanratingversusobtainingcreditratingwithoutloanrating
(a) Loan ratingit
0.004
0.067*
0.051**
(0.017)
(0.009)
(0.029)
0.185**
0.105**
0.228**
(b) Loan ratingit*Unratedi,1994
(0.031)
(0.017)
(0.058)
0.147**
0.041**
0.172**
(c) Creditrating,without loan ratingi,
(0.017)
(0.008)
(0.028)
Difference:(a) + (b) - (c)
0.123+
0.068++
0.089++
Panel B: Obtaining loan rating versus obtaining unrated loan
0.052**
0.007
0.071*
(a) Loan ratingit,
(0.017)
(0.009)
(0.030)
0.198**
0.108**
0.249**
(b) Loan ratingi,*Unratedi,1994
(0.031)
(0.017)
(0.058)
0.009*
0.016
(c) Unratedloani,
0.011*
(0.005)
(0.004)
(0.009)
0.053**
0.013**
0.083**
(d) Unratedloanit*Unratedit
(0.007)
(0.005)
(0.013)
Difference:(a) + (b) - (c) - (d)
0.186++
0.093++
0.221++
0.013
(0.009)
0.071**
(0.018)
0.024**
(0.008)
0.060++
0.020*
(0.009)
0.076**
(0.018)
0.013*
(0.003)
0.025**
(0.004)
0.058++
This table presents two counterfactualanalyses. Panel A reportscoefficient estimates from firm fixed effects
regressions relating outcomes to an indicatorfor whether the firm obtains a loan rating and an indicatorfor
whetherthe firminitially obtainsa creditratingwithouta loan rating.Panel B reportscoefficient estimatesfrom
firm fixed effects regressionsrelatingoutcomes to an indicatorfor whetherthe firmobtains a loan ratingand an
indicatorfor whetherthe firm obtains an unratedloan. The regressionspecificationreportedin column 1 also
includes all control variablesin column 2 of Table4, and the regressionspecificationsreportedin columns 2-4
include all control variablesin column 2 of Table 7. All regressionsinclude year indicatorvariablesinteracted
with two-digit SIC industrycodes; standarderrorsare clustered at the firm level. *,** indicate that coefficient
estimate is statistically distinct from 0 at the 5 and 1% levels, respectively.+,++ indicate that difference in
coefficient estimates is statisticallydistinctfrom 0 at the 5 and 1%levels, respectively.
1685
concernwith
4.4.2 Advancementsin the loan salesmarket. An additional
the empirical strategyis that advancementsin the secondaryloan marketoccurredsimultaneouslywith the introductionof loan ratings.For example, the
Loan Syndicationand TradingAssociation (LSTA) was founded in 1995 and
certaintradingconventionswere introducedin 1996. The worryis thatadvancements in the secondaryloan marketare responsiblefor the trendsdocumented
above, as opposed to the introductionof loan ratings.
The evidence does not supportthis view. In fact, the major impact of the
introductionof loan ratings was complete before the secondaryloan market
reachedsignificantvolumes. Accordingto the LPC, the secondaryloan market
had aggregatevolume of only $80 billion in 1998. In contrast,the aggregate
amountof all initiallyratedloans (bothin andnot in my finalsample)from 1995
through1998 was $490 billion, which reflectsthe rapidadoptionof loan ratings
after their introductionin 1995. Even if one assumes that all the loans traded
on the secondarymarketwere initially ratedloans, only 16%of initially rated
loan amountswere tradedon the secondarymarketin 1998. Consistent with
this growth pattern,althoughthe LSTA was founded in 1995, its coverage of
secondaryloan prices was limiteduntil well afterthe introductionof bankloan
ratings.For example, Gupta,Singh, and Zebedee (2006) reportthatonly about
1686
Table9
Financialand realoutcomesafterbankloanratingis obtained
Dependentvariable
(1)
(2)
(3)
Debt to assets ratioit Asset growthit Acqit/Assetsi,t-_
PanelA: Short-runpersistence(1990-1998)
Bankloanratingobtainedin thisyeari,
0.003
0.060*
After bank loan ratingobtainedi,
Bank loan ratingobtainedin this yeari,*Unratedi,1994
After bank loan ratingobtainedi,*Unratedi,1994
(0.009)
-0.011
(0.011)
0.103**
(0.016)
0.076**
(0.018)
0.014
(0.029)
-0.016
(0.021)
0.230**
(0.058)
0.027
(0.045)
(0.009)
0.004
(0.009)
0.070**
(0.018)
-0.003
(0.015)
0.064*
(0.028)
-0.024
(0.013)
0.224**
(0.056)
-0.062**
(0.023)
0.014
(0.009)
-0.006
(0.004)
0.068**
(0.017)
-0.007
(0.007)
PanelB: Long-runpersistence(1990-2004)
Bank loan ratingobtainedin this yearit
After bank loan ratingobtainedi,
Bank loan ratingobtainedin this yeari,*Unratedi,
1994
After bank loan ratingobtainedi,*Unratedi,
1994
0.004
(0.008)
-0.011
(0.011)
0. 108**
(0.016)
0.073**
(0.017)
This table presentscoefficient estimates from firm fixed effects regressionsrelatingfinancialand real outcomes
at firm iin year t to firm iobtaining a bank loan ratings in year t, and after firm iobtains a bank loan rating.
Panel A includes observationsup to and including 1998, and Panel B includes observationsup to and including
2004. The regressionspecificationreportedin column I also includes all control variablesin column 2 of Table
4, and the regression specifications in columns 2 and 3 include all control variables in column 2 of Table 7.
All regressionsincludeyear indicatorvariablesinteractedwith two-digit SIC industrycodes; standarderrorsare
clustered at the firm level. *,** indicate that coefficient estimate is statisticallydistinct from 0 at the 5 and 1%
levels, respectively.
1687
5. Conclusion
The findings suggest that third-partycertificationby ratingagencies increases
the availabilityof debt financingfor firms,and increasesinvestmentand acquisitions. I informallyextendthe theoreticalframeworkof Holmstromand Tirole
(1997) to show how the innovationof a third-partyratingstechnology reduces
the certificationcost borneby the borrower.The technologyincreasesthe future
income streamsthatthe borrowercan pledge to uninformedlenders,andtherefore increasesthe availabilityof debt financing.The increasedparticipationof
uninformedlendersalso allows the firmto increaseinvestment.
I use this frameworkto empiricallyexplore the introductionof loan ratings
by Moody's and S&P in 1995. My firstset of results suggests thatloan ratings
affordunratedfirmsa uniqueopportunityto obtainthird-partydebtcertification.
The second set of resultsshows thatthe firmsthatobtainloan ratingsexperience
significantincreasesin the availabilityof debtfinancing,asset growth,andcash
acquisitions.The identificationstrategyexploits the cross-sectionalpatternof
firmsthatchoose to obtainloan ratings,and shows thatthe resultsare strongest
amongpreviouslyunrated,lowercreditqualityborrowers.Theseresultssupport
the hypothesis that the introductionof loan ratingscaused an expansionin the
supply of debt financing for these firms. Several robustnesstests imply that
the increases in outcomes would not have been as large had loan ratings not
been available.Finally, I documenta channel throughwhich third-partydebt
ratingsexpandthe supply of debt financing:I find evidence that less-informed
nonbankinstitutionalinvestorsand foreign banks are more willing to serve on
syndicateswhen a firmobtainsa loan rating.
Researchpresentedhere points to two directionsfor futureresearch.First,
there are additionalresearch avenues to examine the real effects of ratings.
For example, many privatecompanies obtained bank loan ratings after their
introductionin 1995. Given that privatecompanies are even less certifiedex
ante than public companies without existing credit ratings, I expect that the
resultspresentedhere would be even strongeramong privatecompanies.Also,
in December 2003, S&P introducedbank loan recoveryratings, which assess
1688
the liquidationvalue of a bank loan and vary within a given loan rating.The
introductionof recovery ratings may furtherimprove liquidity and access to
capital for borrowers who obtain bank loan ratings. In addition, while the
introductionof bankloan ratingsin the US is arguablyone of the largestrating
technology introductionsin the last 15 years, severalratingagencies in various
countries also began rating borrowersduring this time period. An analysis
of the effects of ratingagencies in less financiallydeveloped economies may
furtherstrengthenthe hypothesisthatthird-partyratingorganizationsincrease
the availabilityof externalfinancefor borrowers.
Second, there is a large and growing body of research documenting the
importanceof creditratingsin corporatepolicy (FaulkenderandPetersen,2006;
Kisgen, 2006; Tang,2006), but thereis little empiricalevidence on the precise
mechanismby which ratingsimproveaccess to capital.In otherwords, why do
ratingsreducecertificationcosts andexpandthe base of creditors?Is it because
of the informationproducedby rating agencies? Do agency problems within
organizationsof institutionalinvestorsmake a ratingnecessaryfor investment?
Is it due to holdingrequirementsimposedby regulatoryauthorities?Answering
these questions will likely necessitate detailed informationon the securities
held by institutionalinvestors.An analysis of why many nonbankinstitutional
investorsmust have ratingswould offer valuableinsight into the importanceof
ratingagencies in the economy.
Appendix:
Classification
of Lendersin LPC'sDealscan
Domestic commercialbanks
Bank of New York
CreditSuisse First Boston
NationalCity
NorthernTrust
Bank One
JPMorganChase
WebsterBank
Seattle First National
BankBoston
Suntrust
First NationalBank of Maryland
Firstar
Bank of Oklahoma
Citigroup
Foreigncommercialbanks
IndustrialBank of Japan
Banca di Roma
BNP Paribas
Royal Bank of Scotland
CreditAgricole
TorontoDominion
NationalAustralia
Bank Hapoalim
Allied Irish
Nonbankinstitutionalinvestors
Police OfficersPension System of the City of Houston
RobertFleming &Co Ltd
MountainCLO Trust
EuropeanAmerican
PAMCapitalFunding
ReliastarFinancialCorp
ReliastarLife InsuranceCo
KZH Holding Corp IV
RuralTelephoneFinanceCooperative
CanpartnersInvestmentsIV LLC
KeyportLife InsuranceCo
NorthAmericanSenior Floating Rate Fund
SankatyAdvisors LLC
ORIX LeveragedFinance [aka Orix Business Credit]
RivieraFundingLLC
Stein Roe & Farnham
Fidelity & GuarantyLife InsuranceCo
SRF TradingInc
HarchCapital
PilgrimFund
MackayShields OffshoreHedge Fund
PilgrimPrime
FC CBO Ltd
Prime Income
Sequils-CumberlandI LLC
HighlandCapital
(Continued)
1689
v22 n 4 2009
Appendix:
(Continued)
Investmentbanks
GoldmanSachs
MorganStanley
Bear Steams
LehmanBrothers
Financingcompanies
Foothill
Heller Financial
Congress Financial
Nonbankinstitutionalinvestors
MuirfieldTradingLLC
Debt StrategiesFund III
Stein Roe FloatingRate Ltd
CapitalBusiness Credit
SunAmericaLife InsuranceCo
HartfordLife InsuranceCo
ArchimedesFundingLLC
United of OmahaLife Insurance
PPM Spyglass FundingTrust
Pimco Advisors
PilgrimSenior Income Fund
This table presentsa sample of lendersin LPC's Dealscan, and how I classify these lendersinto categories.
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