Two essays on debt financing

Abstract

The thesis includes two essays on corporate debt contracting. Both essays investigate the factors that affect corporate financing costs. The first essay investigates the impact of political risk on loan contracting. In the second essay, I focus on the anchoring effect in the debt market and will study how a firm's historical borrowing cost serves as the reference point for the current loan issuance. Specifically, in the first essay, I take advantage of a firm-specific political risk measure and investigate the corresponding impact on a firm's loan contracting, including both pricing terms and non-pricing terms. I find that firms associated with a higher level of firm-specific political risk are charged with higher loan spreads. This effect is amplified for firms with an opaquer information environment and firms with a higher level of financial constraints. Besides, the firm-level political risk also tightens the non-pricing loan terms, such as increasing the likelihood of collateral requirement and covenant restrictions. I establish the causality using an IV approach, a matched sample analysis, and placebo tests. At last, I find that the relationship-based borrowing and lobbying engagement attenuate this adverse impact of political risk. In the second essay, I study the anchoring effect in the credit market. I propose a rational explanation where the financial experts (i.e., banks) strategically anchor on borrowers' previous high loan costs and charge higher spread. In detail, I find that at the aggregate level, when the average credit spreads decrease since the firm's last borrowing, banks charge higher loan costs than they should charge justified by the firm fundamentals. However, the firm does not pay less when the average spreads increase. Similarly, at the firm level, when the model predicted loan spread is lower than the previous actual loan spread, banks charge higher costs. When the predicted spread is higher, the firm does not pay less. This asymmetric relationship suggests that banks strategically refer to the previous high spreads in loan pricing. Further analyses show that the relationship becomes stronger when banks have more information advantage and when firms are more bank dependent. Overall, the result suggests that the observed anchoring behavior in the financial market can also be rational and strategic. To summarize, the two essays provide new evidence on the potential determinants that could affect the firm's loan contracting. The second essay also suggests that the well-trained financial exerts could take advantage by pretending to suffer the behavioral biases. These findings could deepen our understanding of loan contracting in the financial market.