Initial conditions and the private debt renegotiation process

1. Initial conditions and the private debt
renegotiation process
Christophe J. Godlewski
UHA & EM Strasbourg, LaRGE Research Center
[contact: godlewski@unistra.fr]
AFFI 2017 Conference, Valence

2. What I do
• Whether & how initial conditions (around loan origination)
influence (private debt) renegotiation
 Exploratory study
• Empirical testing of incomplete contract theory + puzzling
results regarding initial contract terms
 How to write better contracts
• Renegotiation likelihood, dynamics (rounds), degree / scope
(terms) using sequential logit
• Variables: loan, banking pool, borrower and lender, country
• 15k European loans (8k firms from 29 countries) from 1999 to
2015
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion

3. Why I do it
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion
• Renegotiation = mechanism for revising the initial contract (in
case of contingencies) to restore efficiency
• Initial conditions should play an important role
• Theoretical literature is rich / Empirical results emerging / Mixed
- puzzling
• Roberts & Sufi (2009) : no significant impact
• Nikolaev (2016), Saavedra (2015), Paligorova & Santos (2016):
significant impact
• Writing better contracts => design, corporate policy,
performance, financial intermediation, economy !
• Europe = bank-based financial system

4. What do we know (theory)
• Incomplete contracts & financial contracting (Hart; Hart &
Moore)
• Unanticipated or non-contractible events => ex-post
inefficiency of initial contract => renegotiation
• Renegotiation = (optimal?) decision-making mechanism in
advance (initial contract) of contingencies / arrival of new
information
 Allows to contract on unverifiable information
• Contract allocates control & bargaining power => sharing
initial and subsequent surplus / incentives
• Also strategic considerations (signaling, opportunism,
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion

5. What do we know (empirical)
• Growing literature (Godlewski 2014, 2015; Nikolaev 2015; Roberts & Sufi
2009; Roberts 2015), mostly on US
• Renegotiations are frequent, early, with significant modifications of
initial contracts
• Significant & positive AR around renegotiation
• New information, economic conditions, contractual assignment of
bargaining power, financial conditions... Contracting frictions,
agency / information problems…
• Renegotiation helps completing credit contracts and (re)shaping
borrower-lender relationships
• However puzzling results regarding initial conditions
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion

6. How i do it (data & method)
• Multi-sources data (see section 3.1)
• Bloomberg (BPTS): loans, amendments, syndicates + borrowers
• Orbis (BvD): lenders (lead)
• GFDD-WB (Demirgüç-Kunt et al., 2012) + Djankov et al. (2007) +
Favara et al. (2012): country environment (economic, financial,
legal)
• Sample = 8,691 companies; 15,781 loans
• Time span is 1.1.1999 – 31.12.2015 & 29 European countries
• Renegotiation process = decision | dynamics (rounds) / degree
(amended terms)
• Comprehensive approach => sequential logit model
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion

7. How i do it (big picture)
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion

8. What do I find (figures I)
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion
0
20406080
percent
1 2 3 4 5 6 7 8 9
Rounds
0
1020304050
percent
1 2 3 4 5 6
Amendments
Figure 5 Renegotiation dynamics and scope

9. What do I find (figures II)
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion
32.72%
7.992%
4.268%24.82%
21.26%
8.935%
36.64%
6.301%
2.192%22.1%
23.95%
8.813%
Unique_Round
23.56%
11.94%
9.115%31.18%
14.98%
9.222%
Multiple_Rounds
38.71%
6.564%.6422%
25.15%
23.62%
5.316%
Single_Amendment
27.86%
9.151%
7.211%24.56%
19.35%
11.87%
Several_Amendments
Amount Covenants Financial
Covenants Non Financial Definition
Maturity Pricing
Figure 4 Amended terms

10. What do I find (stat. desc.)
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion
Loan & Lenders pool MeanFirm Mean Lender (lead) Mean
Country
(borrower)
Mean
Amount 1 861.15Listed 0.47Lender rated 0.16
Renegotiation
failure
0.39
Maturity 6.41Borrower rated 0.12Total assets 1 200.00Priority 3.33
Covenants 0.09Sales 4 835.52Book value 0.39
Creditors
recover
0.61
Secured 0.40Debt / Equity 1.40TCE ratio 0.04Private credit 113.53
Amount outstanding 4.73Current ratio 0.01LLR / Loans 0.02
Domestic
private debt
33.16
Previous issues 3.80
Operating
margin
0.11RoE 0.10
International
private debt
64.23
Lenders pool Loans / Assets 0.41Stock market 86.87
Lenders 9.24
Volatility of
stock
20.26
League 0.19
Bank
concentration
78.04
Relationship 0.12 Foreign banks 118.82
Same country 0.28 Bank Z score 11.41

11. What do I find (regressions I)
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion
(loan & lenders
pool variables) Reneg. Rounds Amend.
Amount (log) 0.1610*** 0.0083 0.0018
Maturity 0.0653*** 0.0362 0.0299
Covenants 1.5372*** 0.8301*** 0.5870**
Secured 0.6834*** 0.6569*** 0.0325
Amount
outstanding
(log) -0.2039*** 0.0935 -0.0905
Previous issues 0.0542** -0.0270 0.0214
Lenders 0.0448*** 0.0179** 0.0061
League 0.3681*** 0.1649 -0.2447
Relationship -0.3523** 0.6307*** 0.2025
Listed 0.6593*** -0.0617 -0.2296
Borrower rated 0.2494 0.4683** 0.5353**
All regressions include
control variables for:
- main loan currencies
(USD and GBP)
- loan type (term)
- loan purposes
(acquisition, general
corporate, LBO, project
finance, debt refinancing,
working capital)
- Year
- borrower industry sector
- country
Showing significant
variables only
(and skipping robust s.e.
clustered at loan level)

12. What do I find (regressions II)
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion
(lead lender
variables) Reneg. Rounds Amend.
TCE ratio 13.5743** 31.8057***
24.6119**
*
LLR / Loans -3.0478 -5.6084 24.2640**
Loans / Assets -1.7495*** -1.6181 -1.8857*
(country variables) Reneg. Rounds Amend.
Renegotiation failure -1.3675*** -0.6135 0.3420
Priority 0.1794 0.5016** 0.0825
Creditors recovery 0.9792*** -0.2597 0.3952
Private credit -0.0084*** -0.0035 -0.0053
International private
debt 0.0110*** 0.0096** 0.0064
Stock market 0.0050** 0.0014 0.0027
Bank concentration 0.0116** 0.0083 0.0021
Foreign banks 0.0011*** -0.0002 0.0010*
In addition:
Loan & lenders pool +
listed & ratings variables
included
Borrower variables never
significant
Country variables
included separately:
- Legal environment
- Financial development
- Banking structure

13. What do I find (robustness)
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion
• Alternative RHS variables : loan spread, syndicate
concentration, reputation, relationship, borrower, lender,
country variables
• Specific contractual features (frictions): no covenants, no
collateral, no term loans, small syndicates, no
relationship, no rating
• Maturity effect: dropping loans maturing in 2013 / after
2015
• Time: credit & EZ crises
• Place (economic areas): EZ area only / dropping UK

14. Discussion
• Important economic role of initial conditions for the renegotiation
process
• Contractual mechanisms (covenants and collateral) which mitigate
adverse selection and moral hazard have the largest positive
economic impacts
• Organizational mechanisms (lenders pool size, reputation,
relationship
• Soundness and credit portfolio management quality of the lenders
• Institutional protection of creditors protection is the most
economically significant determinant of the renegotiation process
• Survive several robustness checks
What I do
Why I do it
What do we
know
How I do it
What do I
find
Discussion