Do Banks Price Litigation Risk in Debt Contracting? Evidence from Class Action Lawsuits

31 Pages Posted: 20 Jan 2016

See all articles by Qingbo Yuan

Qingbo Yuan

University of Melbourne

Yunyan Zhang

University of Melbourne

Multiple version iconThere are 2 versions of this paper

Date Written: November/December 2015

Abstract

Class action lawsuits can be detrimental to debtholders because they deteriorate defendant firms’ financial position and lower these firms’ value. This study examines whether banks price their borrowers’ litigation risk in debt contracting. We find that banks charge 19% higher interest spreads on loans to lawsuit firms after litigation. In addition, banks monitor lawsuit firms more closely by using tighter non‐price terms. The results are robust after correcting for possible endogeneity issues using the propensity score matching approach. We further find that the effects of lawsuit filing are more pronounced for firms with weaker corporate governance. Following a lawsuit in the industry, banks also perceive an increased likelihood of litigation for industry peer firms and adjust price and non‐price terms accordingly. Finally, we find that the magnitude of the lawsuit filing effect is greater for firms with lower ex‐ante litigation risk. Taken as a whole, our findings suggest that banks, as informed stakeholders, perceive litigation risk to be detrimental and price this risk in debt contracting.

Keywords: debt contracting, litigation risk, bank loans, cost of debt, non‐price terms

Suggested Citation

Yuan, Qingbo and Zhang, Yunyan, Do Banks Price Litigation Risk in Debt Contracting? Evidence from Class Action Lawsuits (November/December 2015). Journal of Business Finance & Accounting, Vol. 42, Issue 9-10, pp. 1310-1340, 2015, Available at SSRN: https://ssrn.com/abstract=2718652 or http://dx.doi.org/10.1111/jbfa.12164

Qingbo Yuan (Contact Author)

University of Melbourne ( email )

Level 7, 198 Berkeley Street, Dept Of Accounting,
Melbourne, Victoria 3010
Australia

Yunyan Zhang

University of Melbourne ( email )

Victoria
Melbourne, 3010
Australia

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