Short-termism spillovers from the financial industry

Review of Financial Studies

Accounting

Review of Financial Studies 2022 Vol 35:7 p 3467-3524

Bird A;Ertan A;Karolyi S A;Ruchti T G

Aytekin Ertan

2022

To meet short-term benchmarks, lenders may alter their monitoring behavior, providing a channel for short-termism to spill over to their borrowers. We find that short-termist lenders are significantly more likely to enforce covenant breaches. This behavior is pronounced when performance benchmarks are precise or salient, and when managers have high pay-performance sensitivity, but not when they face strong shareholder governance. Affected borrowers are more likely to switch lenders, pay higher spreads on renegotiated loans, and reduce investment. Our findings suggest that bank managers trade off relationship capital for income-boosting fees and term changes from covenant enforcement to meet earnings benchmarks

Lending; Short-termism; Covenants; Monitoring; Spillovers; Real effects

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