Xunhua Su

Credit Rationing by Loan Size: A Synthesized Model

We construct a synthesized model to study credit rationing by loan size. In our model, the borrower faces a trade-off between raising debt and exerting costly effort to undertake an investment project. In the absence of agency costs, increasing the loan size at the equilibrium interest rate raises the default risk and hence reduces the average cost of the loan for the borrower, so the borrower always demands a larger loan than what the lender can offer. Furthermore, agency cost raises this excess demand for a given interest rate. If the agency cost is sufficiently high, the borrower is unable to obtain the loan she needs at any interest rate, requiring the use of non-price instruments in the loan contract. In sum, we generalize the two types of credit rationing in a unified framework that facilitates our understanding of credit rationing due to various ex-post agency issues.

The Dynamics of Performance Volatility and Firm Valuation

We construct a model to illustrate the dynamics of cash flow volatility and firm valuation. As a firm progressively invests into its growth opportunities, its book value increases and catches up with its market value, reducing the valuation multiple (Q). Cash flow volatility (CFV) decreases due to the diversification effect of investing into more market segments. We document a positive CFV-Q association, which varies with firm size, investment opportunities, and the correlation across market segments. Empirical findings strongly support the model predictions and are robust to alternative explanations offered by extant studies on firm growth, volatility, and valuation.

Product Market Predatory Threats and Contractual Constraints of Debt

We use a variant of the Hotelling (1929) model to illustrate that, when a firm faces hard payment constraint(s), financially strong rivals may adopt predatory strategies to drive the firm out of the product market and hence to obtain extra profit from enhanced market power later on. Predation is more likely to occur if the payment constraint is contingent on the firm’s performance. The model predicts that higher predatory threats in the product market reduce firm’s use of performance-sensitive debt and this effect should be more pronounced for small firms with large growth opportunities. Through a sample of over 16,000 bank loans to U.S. borrowers in 1997-2008, we find empirical evidence to support these model predictions.

Product Market Threats and Financial Contracting: Evidence from Performance-Sensitive Debt

This paper examines how product market threats shape the use of performance pricing in loan contracts. Loan contracting faces a trade-off between financial markets and product markets: while using contractual terms that are linked to borrower performance -- such as performance pricing -- mitigates borrower-creditor frictions in financial markets, it makes a borrower vulnerable to product market pressures, which often decline borrower performance and make performance pricing more likely to become binding. Supporting this trade-off, we find that product market threats significantly moderate the use of performance pricing in loan contracts, particularly when the benefit of doing so outweighs its cost in exacerbating borrower-creditor frictions in financial markets

Home Equity-Based Refinancing and Household Financial Difficulties: The Case of Norway

Housing prices in Norway and the Norwegian household-debt-to-disposable-income ratio have reached unprecedentedly high levels in recent years, raising debates about whether there is a serious housing bubble. Contributing to the debates, we study home equity-based refinancing in Norway and have two main findings. First, along with soaring housing prices, homeowners significantly withdraw their home equity. This cash-out accounts for at least one-third of outstanding household mortgages and hence substantially contributed to the high debt-to-income ratio. Second, households with large cash-out-to-income ratios are more likely to have financial difficulties. As cash-out refinancing is blamed to be one of the key drivers of the subprime crisis in the United States, our findings call for more attention to home equity-based refinancing in the Norwegian housing market.

Penalty-Free Prepayments, Credit Rationing, and the Use of Upfront Fees in Bank Loans

I argue that non-price credit rationing is a way to maintain borrowers’ flexibility to prepay freely. In my model, if voluntary prepayments are penalty-free, over time good borrowers prepay their loans while bad borrowers stay. This self-selection to prepay leaves the lender with bad borrowers only. Increasing the interest rate alone is not sufficient to compensate the lender for the prepayment risk, and hence the lender resorts to non-price credit rationing. In addition, the lender may employ a non-linear pricing approach in which an upfront fee is charged for loans with relatively high prepayment risk and low refinancing costs. Empirical evidence supports this prediction. Using a sample of 64,555 term loans to U.S. firms between 1987 and 2011, I find that a 100 basis points increase in the loan spread, measuring prepayment risk, leads to a 5.3 basis points average increase in the upfront fee. Moreover, loans with higher refinancing costs, e.g. syndication loans (vs. traditional bank loans), are in general associated with lower upfront fees.