Journal of Financial Economics ] (]]]]) ]]]–]]] Contents lists available at SciVerse ScienceDirect Journal of Financial Economics journal homepage: www.elsevier.com/locate/jfec Corporate ownership structure and bank loan syndicate structure$ Chen Lin a, Yue Ma b, Paul Malatesta c,n, Yuhai Xuan d a Chinese University of Hong Kong, Shatin, N. T., Hong Kong b Lingnan University, Tuen Mun, Hong Kong c University of Washington, Seattle, WA, USA d Harvard Business School, Boston, MA, USA article info abstract Article history: Using a novel data set on corporate ownership and control, we show that the divergence Received 17 December 2010 between the control rights and cash-flow rights of a borrowing firm’s largest ultimate Received in revised form owner has a significant impact on the concentration and composition of the firm’s loan 7 March 2011 syndicate. When the control-ownership divergence is large, lead arrangers form syndicates Accepted 14 March 2011 with structures that facilitate enhanced due diligence and monitoring efforts. These syndicates tend to be relatively concentrated and composed of domestic banks that are JEL classification: geographically close to the borrowing firms and that have lending expertise related to the G21 industries of the borrowers. We also examine factors that influence the relation between G32 ownership structure and syndicate structure, including lead arranger reputation, prior G34 lending relationship, borrowing firm informational opacity, presence of multiple large owners, laws and institutions, and financial crises. Keywords: & Ownership structure 2011 Elsevier B.V. All rights reserved. Excess control rights Syndicated loans 1. Introduction borrowing in international bond markets (Chui, Domanski, Kugler, and Shek, 2010). Unlike a traditional bank loan, Over the past two decades, the syndicated loan market which typically involves a single creditor, a syndicated loan has become the most important source of global corporate unites a group of lenders in which a lead arranger originates financing. International syndicated lending amounted to the loan and performs due diligence and monitoring, and $1.8 trillion in 2009, surpassing the $1.5 trillion of corporate the participant banks fund parts of the loan (Esty, 2001). The syndication process therefore generates an additional ele- ment of moral hazard within the syndicate between the $ lead arranger and the other syndicate members, besides We are grateful for helpful comments and suggestions from Stijn Claessens, Ben Esty, Stuart Gilson, Paul Gompers, Joel Houston, Victoria the typical agency problems between the borrower and the Ivashina, Christopher James, Simon Johnson, Rafael La Porta, Ross Levine lender that exist in a lending relationship (Diamond, 1984; (the referee), Bill Schwert (the editor), Andrei Shleifer, Laura Starks, Holmstrom and Tirole, 1997). Despite the importance of Jeremy Stein, Bele´n Villalonga, Yihui Wang, and seminar participants at syndicated loans and the uniqueness of the syndication Zhongnan University of Economics and Law, the American Finance Association Annual Meeting, the Asian Finance Association International process, little is known about how loan syndicates are Conference, and the China International Conference in Finance. We structured to address and mitigate moral hazard problems thank Arbitor Ma, Pennie Wong, and William Alden for help with data both at the borrowing firm and within the syndicate. collection. Lin and Xuan gratefully acknowledge financial support from In this paper, we focus on the divergence between Chinese University of Hong Kong and the Division of Research of the corporate ownership and control at the borrowing firm to Harvard Business School, respectively. n Corresponding author. explore how corporate ownership structure influences the E-mail address: [email protected] (P. Malatesta). bank loan syndicate structure. In many publicly listed 0304-405X/$ - see front matter & 2011 Elsevier B.V. All rights reserved. doi:10.1016/j.jfineco.2011.10.006 Please cite this article as: Lin, C., et al., Corporate ownership structure and bank loan syndicate structure. Journal of Financial Economics (2012), doi:10.1016/j.jfineco.2011.10.006 2 C. Lin et al. / Journal of Financial Economics ] (]]]]) ]]]–]]] firms around the world, control rights of the dominant costly (Gertner and Scharfstein, 1991; Bolton and Scharfstein, shareholders often exceed their cash-flow rights via the 1996; Brunner and Krahnen, 2008). As a consequence, diffuse use of dual-class shares, pyramidal structures, and multiple loan ownership can be used as a pre-commitment mechan- control chains (e.g., La Porta, Lo´pez-de-Silanes, and Shleifer, ism by lenders to deter strategic defaults (Bolton and 1999; Claessens, Djankov, and Lang, 2000; Laeven and Scharfstein, 1996; Esty and Megginson, 2003). Therefore, if Levine, 2008, 2009; Gompers, Ishii, and Metrick, 2010). In creditors are concerned with strategic defaults by the bor- such firms, the controlling shareholders have the ability to rowing firms when a large divergence exists between divert corporate wealth for private benefits without bearing corporate control and cash-flow rights, a diffuse syndicate the full financial consequences and, therefore, have strong ownership might be preferred. In this regard, the creditors’ incentives to engage in tunneling and other moral hazard incentives to form a more diffuse syndicate might be activities (Shleifer and Vishny, 1997; Johnson, La Porta, increasing in the divergence between corporate control and Lo´pez-de-Silanes, and Shleifer, 2000).1 Many of these activ- cash-flow rights. These considerations suggest a negative ities increase the default risks, impair collateral values and, relation between corporate control-ownership divergence as a consequence, increase the expected costs of financial and syndicate concentration. The overall effect of corporate distress (Lin, Ma, Malatesta, and Xuan, 2011).2 In anticipation control-ownership divergence on syndicate concentration is of the increased credit risk, more intense due diligence and an empirical question that we explore in this study. monitoring efforts are required before lending takes place. The divergence between ownership and control at the However, as suggested in the framework of Holmstrom and borrowing firm can also affect the composition of the loan Tirole (1997), the lead arranger has an incentive to shirk the syndicate, including foreign lender participation and the monitoring responsibilities, especially when more intense overall lending expertise of the syndicate members. It is monitoring is required, because the monitoring efforts are well documented that greater physical distance between costly and unobservable, and the lead arranger owns only the lender and the borrower makes the ex-ante screening part of the loan. The lead arranger bears most of the costs for and ex-post monitoring more difficult and generates the due diligence on the borrower ex ante and the monitor- higher agency costs (Stein, 2002; Esty, 2004). The dis- ing of the borrower ex post yet retains only a fraction of the tance-driven agency costs are further aggravated by the loan. Therefore, the lead arranger could lack the incentive to agency problems induced by the control-ownership diver- provide the optimal level of efforts (Sufi, 2007; Ivashina, gence at the borrowing firms. As a result, foreign banks 2009). Participant banks should take the lead arranger’s might be less willing to lend to such firms that require moral hazard problem into account and demand that a monitoring-intensive relationship loans. Moreover, as greater fraction of the loan be held by the lead arranger for Esty (2004) suggests, foreign banks are more susceptible incentive purposes if the borrowing firm requires more due to expropriation risks because they are often treated diligence and monitoring. Moreover, a larger portion of the unfairly in corporate default situations, especially in loan retained by the lead arranger not only signals a credible relational functions such as debt restructuring or collat- commitment by the lead arranger in due diligence and eral seizing.3 Therefore, we expect the syndicate partici- monitoring, but also provides a strong signal of borrower pation rate of foreign lenders to be negatively related to quality (Sufi, 2007; Ivashina, 2009). Therefore, the fraction the divergence between control and cash-flow rights of held by the lead arranger of a syndicated loan should be the dominant shareholders of the borrower. increasing in the divergence between control and cash-flow The lending expertise of the syndicate also could be rights of the borrowing firm’s dominant shareholders. It affected by the divergence between ownership and control follows that syndicates lending to firms with large control- at the borrowing firm. Lender loan portfolio concentration ownership deviations should be more concentrated than in a particular industry is driven by synergies in information those lending to firms with small deviations. collection and monitoring (Ivashina, 2009). Banks with On the other hand, countervailing factors could induce a industry-specific expertise are more likely than other banks diffuse syndicate structure in the face of control-ownership to lend to borrowers that require industry-specific knowl- divergence. Diffuse loan ownership can facilitate diversifica- edge and intense monitoring, such as firms with great tion of risk exposure across lenders (Esty and Megginson, tunneling risks caused by large divergences between own- 2003).