Lender Exposure and Effort in the Syndicated Loan Market

This article tests for asymmetric information problems between the lead arranger and the participants in a lending syndicate. One problem comes from adverse selection, whereby the lead has a private informational advantage over participants. A second problem comes from moral hazard, whereby the lead puts less effort in monitoring when it retains a smaller loan share. Applying an instrumental variables strategy using lending limits, borrower performance is improved by increasing the lead's share. The focus is on separating moral hazard from adverse selection and the results are consistently indicative of monitoring. First, the lead's share is more important for revocable credit lines than for fully funded term facilities. Second, a lead with greater liquidity risk reduces its share resulting in worse borrower performance, but its liquidity risk does not affect the quality of credits it chooses to syndicate in the first place. Third, covenants are paired with a higher lead share, and the sensitivity between share and borrower ex post performance is greater on loans with more covenants.