Organizational Forms and the Contracts of Bank Loans

Motivation: Prior literature focuses on one or two different types of organizational forms at a time to measure their impact on the cost of bank loans. However, without recognizing the effects of all major forms of organizations in empirical models, we cannot accurately figure out the most influential type of diversification affecting bank loan contracting. This paper is the first to consider all three important organizational forms, that is, industrial diversification, global diversification, and geographic dispersion, in an empirical framework to find out which types of diversification do matter in contracting bank loans. Premise: In finding out the influence of organizational forms on bank loan contracting, I investigate three types of diversification: Industrial diversification that captures a firm's operations in different industries, global diversification that identifies if a firm has operations outside of the United States, and geographic dispersion that captures if a firm has subsidiaries located in different regions within the United States. Each type of diversification has its risk advantages and disadvantages, which to some extent overlap with each other. Thus, once these measures of diversification in a single model are included, the type of diversification that most influences bank loan contracting can be identified. Approach: Using a sample of publicly listed U.S. companies with 16,704 loan-year observations from 1994 to 2009, this paper examines the pricing of bank loans and the non-price loan terms from the context of industrial diversification, global diversification, and geographic dispersion. The main empirical models of the paper use panel models and then employ the instrumental regression model in the robustness tests. Results: I find that, on average, globally diversified firms could incur a 7.7 to 14.5 percent increase in loan pricing compared to the concentrated firms or the firms that are not diversified in any dimension. The other types of firms incurring a higher cost of bank debt are the firms that are only geographically dispersed and the firms that are diversified in all three forms. Examining the effects of organizational forms on the non-price loan terms, I observe that covenant restrictions are generally higher for the geographically dispersed firms that are either industrially or globally diversified. Conclusion: The evidence of this paper implies that global diversification predominantly exposes a firm to a greater level of credit risk compared to industrial diversification or geographic dispersion. The impacts of other types of diversification, such as industrial diversification and geographic dispersion, on the cost of bank loans are negligible compared to the globalization of firms. Consistency: The findings of the paper support the argument of prior literature that internationalization is associated with an exposure to a host of local and foreign risk factors and agency problems that eventually increases the cost of bank loans.