Conditional Effects of Covenants on Loan Pricing

I explore a sample of private bank loan agreements collected from LPC Dealscan and empirically test the marginal effect of covenants inclusion on loan spread, conditioning on the extent of information asymmetry between the firms and the lead banks. I apply two measures of covenants inclusion, namely number of covenants and a covenant index. By constructing information transparency indices and employing interaction terms in the 2-Stage Least Square setting, I provide evidence that the degree of information transparency exerts influence on how covenants and loan pricing are related. When information between the contract parties is relatively opaque, including more covenants results in lower loan spread; when the information transparency is relatively enhanced, i.e. transparency indicator points to higher level, intensive covenants are combined with higher price. The analysis also shows that information asymmetry is itself priced in the private loan contracts, where transparent borrowers pay significantly less on their debts, which is in line with the asset pricing theory