Dissimilarity Matters : Evidence from Private Debt Contracts

We examine how year-over-year financial statement textual dissimilarity is related to the pricing of private debt contracts. Our findings support a higher loan spread for firms with high financial statement dissimilarity, independent from financial statement readability and comparability. Dissimilarity in financial statements contains incremental information about weak firm performance and a higher probability of performance covenant violations. Banks impose more covenant restrictions, especially performance covenants, on borrowers with higher financial statement dissimilarity. The relationship between financial statement dissimilarity and loan spreads is stronger when financial statements have a more ambiguous tone, and when the borrowers have an opaque information environment. Financial statement dissimilarity increases bank loan spreads when banks do not have any relationship with borrowers or when such borrowing firms are subject to lower monitoring from institutional investors and directors. Overall, our findings suggest that lenders pay additional attention to the dissimilarity of 10-K reports when deciding on the price and covenants of private debt contracts