Gus De Franco

Peer Choice in CEO Compensation

Current research shows that firms are more likely to benchmark against peers that pay their Chief Executive Officers (CEOs) higher compensation, reflecting self-serving behavior. We propose an alternative explanation: the choice of highly paid peers represents a reward for unobserved CEO talent. We test this hypothesis by decomposing the effect of peer selection into talent and self-serving components. Consistent with our prediction, we find that the association between a firm’s selection of highly paid peers and CEO pay mostly represents compensation for CEO talent.

Debt Analysts’ Views of Debt-Equity Conflicts of Interest

We investigate how the tone of sell-side debt analysts’ discussions about debtequity conflict events affects the informativeness of debt analysts’ reports in debt markets. Conflict events such as mergers and acquisitions, debt issuance, share repurchases, or dividend payments potentially generate asset substitution or wealth expropriation by equity holders. We document that debt analysts routinely discuss these conflict events in their reports. More importantly, discussions about conflict events that we code as negative are associated with increases in credit spreads and bond trading volume. Consistent with the informational value of debt analysts’ discussions in secondary debt markets, we find that negatively coded conflict discussions predict higher bond offering yields in the primary bond market. In additional analyses, we measure the tone of debt analysts’ discussions based on their disagreement with the tone of equity analysts’ discussions and find that the informativeness of debt analysts’ reports is higher when our coding indicates that conflict events are viewed negatively by debt analysts but positively by equity analysts.

Managerial Ability and Bank-Loan Pricing

This paper examines the impact of borrowers’ managerial ability on lenders’ bank-loan pricing and the channels through which managerial ability affects bank-loan pricing. Using a large sample of U.S. bank loans, we provide evidence that higher managerial ability is associated with lower bank-loan prices. This effect is stronger in firms with high information risk, suggesting that an important channel for managerial ability to affect bank-loan pricing is through improved financial disclosure to mitigate information asymmetry. The relation is also stronger for firms with weak business fundamentals, implying that another channel is through improved business performance. Of these two mechanisms, path analysis suggests that the business-fundamentals mechanism is the more important channel through which managerial ability affects bank-loan pricing.

Product Market Peers in Lending: Information Processing Efficiencies and Proprietary Costs

This study examines how product market peers affect lending relationships. We contend that firms are more likely to borrow from a bank that has previously lent to a peer, to mitigate information asymmetry with the bank when potential information processing efficiencies are greater (i.e., information efficiency hypothesis), but there will be a decreased propensity to borrow from a shared lender when the costs of leaking proprietary information are greater (i.e., proprietary information leakage hypothesis). We find that, on average, firms avoid borrowing from banks that lend to a product market peer. We also document evidence consistent with both hypotheses in both cross-sectional and difference-in-difference research designs. In additional analysis, we examine the pricing of loans and observe loan pricing effects consistent with these two hypotheses.This study examines the effect of banks’ competitor-specific knowledge, whether a bank has lent money to a firm’s product-market competitors (i.e., rivals), on the matching of firms to lenders. We find an increased propensity of firms obtaining a loan from a bank that has also lent to firms’ rivals. We find that this relation is accentuated for firms with high levels of financial reporting opacity and attenuated for firms with high proprietary costs. These cross-sectional results are consistent with the benefits of information efficiencies being greater when borrowers’ financial reporting opacity is higher and the costs of leaking information being higher when firms have greater potential proprietary information. We also assess the economic consequences of our main findings by examining the pricing of bank loans. Consistent with lenders being able to leverage their inside knowledge of firms within the same product market and transfer the information efficiencies to borrowers, we document a reduction in the spread over LIBOR when firms borrow from banks that have previously lent to their rivals.

Similarity in Bond Covenants

We examine the economic consequences associated with the inclusion of covenants with similar levels of restrictiveness in bond contracts. Using a unique Moody’s dataset on the quality of bond covenants, we develop measures that capture similarity in bond covenant terms by comparing the restrictiveness of a bond’s covenants with the covenant restrictiveness of previously issued peer bonds. Consistent with similarity in covenants reducing bondholders’ contracting and comparability costs, we document that bonds with more similar covenant restrictiveness receive significantly lower yields at issuance. These bonds are also characterized by greater liquidity in the secondary market and are more likely to be held by long-term bond investors, such as insurance companies. Our results highlight the benefits of covenant similarity and suggest that the use of covenants with similar restrictiveness levels brings contracting and comparability cost savings that may be larger than the monitoring benefits provided by covenants with more tailored credit protection.

Managerial ability and bank-loan pricing: DE FRANCO et al.

This paper examines the impact of borrowers’ managerial ability on lenders’ bank-loan pricing and the channels through which managerial ability affects bank-loan pricing. Using a large sample of U.S. bank loans, we provide evidence that higher managerial ability is associated with lower bank-loan prices. This effect is stronger in firms with high information risk, suggesting that an important channel for managerial ability to affect bank-loan pricing is through improved financial disclosure to mitigate information asymmetry. The relation is also stronger for firms with weak business fundamentals, implying that another channel is through improved business performance. Of these two mechanisms, path analysis suggests that the business-fundamentals mechanism is the more important channel through which managerial ability affects bank-loan pricing.