Byron Y. Song

Auditor Quality and Ownership Structure of Syndicated Loan Deals

This study investigates a hitherto unexplored question of whether banks and other private lenders take into account the quality of external auditors appointed by borrowers when structuring the ownership of syndicated loans. Our empirical analyses, using a sample of U.S. loan data from 1992 to 2007, show several interesting findings. First, the percentage of a syndicated loan retained by lead arrangers is smaller for the loan to borrowers with Big 4 auditors than for the loan to borrowers with non-Big 4 auditors. Second, the effect of auditor quality (Big 4 versus non-Big 4) on loan ownership structure is more pronounced when the borrower has a high default risk. Finally, our change analyses show that the change in auditor quality is associated with the change in the ownership structure of syndicated loans: upgrading auditor from a non-Big 4 auditor to a Big 4 auditor leads to a significant decrease in the ownership retention by the lead arrangers. Overall, our results suggest that auditor quality plays an important role in loan syndication by alleviating information asymmetries between lead arrangers and non-lead participating lenders of the syndicated loan.

Investment decisions and bank loan contracting

Purpose - The purpose of this paper is to examine how a firm’s investment behavior relates to its subsequent bank loan contracting. Design/methodology/approach - Using a sample of US firms during the period 1992-2011, the authors examine the association between overinvestment (underinvestment) and three characteristics of bank loan contracts: loan spread, collateral requirement, and loan maturity. Findings - The authors find that overinvesting firms obtain loans with higher loan spreads. Additional tests show that the effect of overinvestment on loan spreads is generally more pronounced in firms with lower reputation, weaker shareholder rights, and lower institutional ownership. The effect of overinvestment on collateral requirement is mixed, and investment efficiency has no significant relation to loan maturity. Research limitations/implications - The results are subject to the following caveats. First, while the study provides empirical evidence that investment efficiency affects bank loan contracting terms, especially the cost of bank loans, the underlying theory is not well-developed. The authors leave it up to future research to provide a theoretical framework to clearly distinguish the cash flow and credit risk effects of past investment behavior from those of existing agency conflicts. Second, due to data limitation, the sample size is small, especially when the authors control for corporate governance measured by Practical implications - The finding that overinvestment is costly to corporations suggests that managers should consider the potential trade-offs from such investment decisions carefully. The evidence also alerts shareholders and board members to the importance of monitoring management investment decisions. In addition, the authors find that corporate governance moderates the relationship between investment decisions and cost of bank loans, suggesting that it would be beneficial to design effective governance mechanisms to prevent management from empire building and motivate managers to pursue efficient investment strategies. Originality/value - First, the findings enhance understanding of the potential economic consequences of overinvestment decisions in the context of a firm’s private debt contracting. The evidence suggests that lenders perceive higher credit risk from overinvestment than from underinvestment, likely because firms squander cash in the current period by investing in (negative net present value) projects that are likely to result in future cash flow problems. Second, the study contributes to the literature on the determinants of bank loans by identifying an observable empirical proxy for uncertainty in future cash flows that increases credit risk.

Dividend Policy and Investment Efficiency -- The Changes of the Mandatory Dividends Payment

This paper demonstrates important interactions between dividend policy and investment efficiency. We find that dividend payout can improve investment efficiency, especially can mitigate over-investment. Prior research shows that dividend payout help mitigate over-investment problem (Biddle, Hilary, and Verdi, 2009). However, firms with low investment discretionary may be maturer, have rich cash flows, and prefer to issue dividends. We use a setting to solve this problem. In 2006, China Securities Regulatory Commission (CSRC) issues documents and declares that firms need to issue at least 20% of their net profit as cash dividends accumulatively in continuous three years before refinancing. In 2008, this rate increases to 30%. We find the negative effect of dividend on over-investment is more significant after 2006. Because this regulation is associated with refinancing, we use cross-sectional analysis to compare firms with and without refinancing activities. This can exclude the effect of the macroeconomic factors and other regulation factors. We find that firms with refinancing activities have negative effect on the depressant effect of dividend payout on over-investment. This effect is more significant after 2006. This mitigating effect is mainly affected by the shock in 2006, when the refinancing activities are first linked to a certain amount of dividend payments. Besides, we also find that the larger size of refinancing, the more negative effect on the depressant effect of dividend payout on over-investment is. Larger size of refinancing means that firms are more likely to have larger investment projects. Those kinds of firms really need cash to catch the investment opportunities. At that time, CSRC asks them to issue at least 20% of net profit as cash dividends can attenuate the over-investment more pronouncedly. These policy events provide exogenous shocks, which can attenuate the endogeneity concern. Our finding is consistent with prior the research (Biddle et al., 2009). It is robust when we use different model to estimate investment residual and after other robust tests. After analyzing, we can conclude that dividend payout can alleviate over-investment.

Reputable Inside Directors and Internal Control Effectiveness

The study investigates whether non-CEO inside directors with reputation incentives affect the effectiveness of a firm’s internal control over financial reporting. Internal control effectiveness is an important indicator of financial reporting quality. Using a large sample of 7,352 firm-year observations from 2004 to 2012, we find that firms with RIDs are less likely to report internal control weaknesses (ICWs). We also find that RIDs have a more pervasive impact on account-level ICWs than company-level ICWs. Empirical results also demonstrate that the association between RIDs and ICWs is more pronounced for firms with lower audit quality, higher CEO entrenchment, and higher cost of misreporting. These findings add to the few empirical studies examining the determinants of ICWs and have corporate governance policy implications for regulators by supporting the desirable role of inside directors in terms of efficient contracting.