The certification value of private debt renegotiation and the design of financial contracts

What is it about?

By using a sample of bank loan renegotiations by European firms, I show that the renegotiation of financial contracts bears a certification value, while deeply changing the contractual features of the loan over time, to the benefit of shareholders. I find that amendments to financial covenants and to loan amounts increase the cumulative abnormal returns of a borrowing firm by 10–15%. Early and less frequent renegotiations of bilateral loans with short maturities also imply a positive stock market reaction. Amendments signaling the early accrual of new and positive information allow increasing firm value.

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Why is it important?

Overall, through this first empirical analysis of bank loan renegotiations in Europe, I show that renegotiating financial contracts matters for shareholders and that it bears important certification effects. Amendments can imply very large changes in the borrower’s financial structure. They also reflect the evolution of information asymmetry, moral hazard, monitoring and bargaining power. In other words, renegotiation shapes the borrower–lender relationship and thus the efficiency of the financial contract. Hence, the dynamic of the renegotiation process matters as well, especially its timing, frequency and scope. Both parties should take all these features into account to the contract with respect to shareholder value.