Regina Wittenberg Moerman

We investigate how credit default swaps (CDSs) affect lenders’ incentives to initiate new lending relationships. We predict that CDSs reduce adverse selection that nonrelationship lead arrangers face when competing for loans. Consistently, we find that a loan is more likely to be syndicated by a nonrelationship lead arranger following CDS trading initiation on a borrower’s debt. We also show that borrowers that obtain loans from nonrelationship lead arrangers in the post-CDS trading initiation period are more opaque, in line with the effect of CDSs being more pronounced for borrowers for which adverse selection costs are higher. Further analyses show that, relative to relationship lead arrangers, nonrelationship lead arrangers have lower monitoring incentives in the post-period, as reflected by less restrictive covenants and performance pricing provisions they impose and by the reduced loan shares they retain. Moreover, we find that borrowers of nonrelationship lead arrangers following CDS trading initiation have higher growth opportunities and more volatile operations, consistent with such borrowers benefiting more from weaker restrictions on their activities imposed by lenders. Lastly, lower monitoring incentives of CDS-protected nonrelationship lead arrangers also decrease the propensity of inexperienced participants to join their syndicates. Overall, our findings suggest that CDS trading significantly changes nonrelationship lending dynamics.

We investigate how institutional (non-commercial bank) investors that simultaneously invest in a firm's debt and equity (dual-holders) influence the firm's voluntary disclosure. Because institutional dual-holders trade on private information gleaned through lending relationships, we predict and find that borrowers increase earnings forecast disclosure to reduce these investors' information advantage following the origination of loans with their participation. We also show that the increase in disclosure is stronger when the access to a borrower's private information endows dual-holders with a greater information advantage and when the consequences of this access are likely to be more pronounced. We further find that institutional dual-holders earn excess returns when trading equity of non-guider firms following loan origination, but not when firms issue guidance, confirming that earnings disclosure helps level the playing field among investors. Our findings highlight that firms actively use disclosure to mitigate the adverse effect of dual-holders on their information environment.