Abstract
The present study is focused on the renegotiation of small debt contracts for small and medium-sized enterprises (SMEs). We use a proprietary database from a Brazilian bank and find that, when compared to large loans, the probability of renegotiation of small loans is much lower. We argue that this is due to the lack of ex-ante contingencies in this kind of loan, which reduces the transfer of control to the lender in situations in which the borrower is not in financial distress, and to the lower bargaining power of SMEs when compared to large public companies. We find that borrower delinquency events and borrower bargaining power proxies are positively related to the probability of small loan renegotiation. We also find that delinquency events reduce the probability of borrower-friendly outcomes as well as the number of key contractual terms renegotiated favorably to the borrower. Further, we find that the borrower’s bargaining power increases the likelihood that the borrower will obtain a favorable outcome and a greater number of favorable key contractual terms in the outcome of the renegotiation.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Data Availability
The data that support the findings of this study are available from the corresponding author upon request.
Notes
Theoretically, collateral also provides an incentive for the bank to monitor loans (Rajan and Winton 1995). However, collateral is used only in a minor part of the contracts in our sample, with reduced incentive for the bank to monitor this kind of loan.
As will be seen in the next Section, most debt contracts in our sample are unsecured. In such cases, the remaining alternative for the bank to enforce payment is to register the borrower in national credit restriction databases. This makes renegotiation an even more attractive alternative for the bank in the event of missed payments, as it is often the only way for the lender to recover the funds granted.
We use this expression to refer to outcomes that cannot be labeled as favorable to borrowers, but which are not necessarily unfavorable either.
It should be borne in mind that it may be in the bank’s interest to make concessions to the borrower even in a situation where the bank’s bargaining power is absolute, in order to increase the prospect of recovering the funds granted.
7 References
Aghion, P., Bolton, P.: An incomplete contract approach to financial contracting. The Rev. Econ. Stud. (1992). https://doi.org/10.2307/2297860
Aghion, P., Dewatripont, M., Rey, P.: Renegotiation design with unverifiable information. Econometrica. (1994). https://doi.org/10.2307/2951613
Berger, A.N., Udell, G.F.: Collateral, loan quality and bank risk. J. Monet Econ. (1990). https://doi.org/10.1016/0304-3932(90)90042-3
Bester, H.: The role of collateral in a model of debt renegotiation. J. Money Credit Bank. (1994). https://doi.org/10.2307/2078035
Bolton, P.: Renegotiation and the dynamics of contract design. Eur. Econ. Rev. (1990). https://doi.org/10.1016/0014-2921(90)90102-5
Cenni, S., Monferrà, S., Salotti, V., Sangiorgi, M., Torluccio, G.: Credit rationing and relationship lending. Does firm size matter? J. Bank. Financ. (2015). https://doi.org/10.1016/j.jbankfin.2014.12.010
Demerjian, P.R.: Uncertainty and debt covenants. Rev Acc. Stud. (2017). https://doi.org/10.1007/s11142-017-9409-z
Denis, D.J., Wang, J.: Debt covenant renegotiations and creditor control rights. J. Financ Econ. (2014). https://doi.org/10.1016/j.jfineco.2014.04.003
Dewatripont, M., Maskin, E.: Contract renegotiation in models of asymmetric information. Eur. Econ. Rev. (1990). https://doi.org/10.1016/0014-2921(90)90103-6
Dou, Y.: The debt-contracting value of accounting numbers and financial covenant renegotiation. Manage. Sci. (2020). https://doi.org/10.1287/mnsc.2018.3276
Freudenberg, F., Imbierowicz, B., Saunders, A., Steffen, S.: Covenant violations and dynamic loan contracting. J. Corp. Finance. (2017). https://doi.org/10.1016/j.jcorpfin.2017.05.009
Gârleanu, N., Zwiebel, J.: Design and renegotiation of debt covenants. Rev. Financ Stud. (2009). https://doi.org/10.1093/rfs/hhn017
Godlewski, C.J.: The dynamics of bank debt renegotiation in Europe: A survival analysis approach. Econ. Model. (2015). https://doi.org/10.1016/j.econmod.2015.03.017
Godlewski, C.J.: Debt renegotiation and the design of financial contracts. J. Financial Serv. Res. (2019). https://doi.org/10.1007/s10693-019-00311-x
Gorton, G., Kahn, J.: The design of bank loan contracts. Rev. Financ Stud. (2000). https://doi.org/10.1093/rfs/13.2.331
Grunert, J., Norden, L.: Bargaining power and information in SME lending. Small Bus. Econ. (2012). https://doi.org/10.1007/s11187-010-9311-6
Harris, M., Raviv, A.: The role of games in security design. Rev. Financ Stud. (1995). https://doi.org/10.1093/rfs/8.2.327
Hart, O., Moore, J.: Incomplete contracts and renegotiation. Econometrica. (1988). https://doi.org/10.2307/1912698
Hart, O., Moore, J.: Default and renegotiation: A dynamic model of debt. Q. J. Econ. (1998). https://doi.org/10.1162/003355302753399436
Huberman, G., Kahn, C.M.: Limited contract enforcement and strategic renegotiation.Am. Econ. Rev.(1988a). https://www.jstor.org/stable/1809146
Huberman, G., Kahn, C.M.: Strategic renegotiation. Econ. Lett. (1988b). https://doi.org/10.1016/0165-1765(88)90100-0
Ikeda, R., Igarashi, Y.: Credit risk analysis with creditor’s option to extend maturities. Ann. Finance. (2016). https://doi.org/10.1007/s10436-016-0281-9
Maskin, E., Moore, J.: Implementation and renegotiation. Rev. Econ. Stud. (1999). https://doi.org/10.1111/1467-937X.00077
Moraux, F., Silaghi, F.: Inside debt renegotiation: Optimal debt reduction, timing, and the number of rounds. J. Corp. Finance. (2014). https://doi.org/10.1016/j.jcorpfin.2014.05.012
Nikolaev, V.V.: Scope for renegotiation in private debt contracts. J Acc. Econ. (2018). https://doi.org/10.1016/j.jacceco.2017.11.007
Nini, G., Smith, D.C., Sufi, A.: Creditor control rights, corporate governance, and firm value. Rev. Financ Stud. (2012). https://doi.org/10.1093/rfs/hhs007
Petersen, M.A., Rajan, R.G.: The benefits of lending relationships: evidence from small business data. J. Finance. 49(1), 3–37 (1994). https://doi.org/10.2307/2329133
Prilmeier, R.: Why do loans contain covenants? Evidence from lending relationships. J. Financ Econ. (2017). https://doi.org/10.1016/j.jfineco.2016.12.007
Rajan, R.G.: Insiders and outsiders: The choice between informed and arm’s-lenght debt. J. Finance. (1992). https://doi.org/10.1111/j.1540-6261.1992.tb04662.x
Rajan, R.G., Winton, A.: Covenants and collateral as incentives to monitor. The J. Finance. (1995). https://doi.org/10.1111/j.1540-6261.1995.tb04052.x
Roberts, M.R., Sufi, A.: Renegotiation of financial contracts: Evidence from private credit agreements. J. Financ Econ. (2009a). https://doi.org/10.1016/j.jfineco.2008.08.005
Roberts, M.R., Sufi, A.: Financial contracting: A survey of empirical research and future directions. Annu. Rev. Financ Econ. (2009b). https://doi.org/10.1146/annurev.financial.071808.145241
Roberts, M.R.: The role of dynamic renegotiation and asymmetric information in financial contracting. J. Financ Econ. (2015). https://doi.org/10.1016/j.jfineco.2014.11.013
Tirole, J.: Incomplete contracts: Where do we stand? Econometrica (1999). https://doi.org/10.1111/1468-0262.00052
Uchida, H.: Empirical determinants of bargaining power. SSRN Electron. J. (2011). https://doi.org/10.2139/ssrn.954534
Funding
This work was supported by the FCT - Fundação para a Ciência e a Tecnologia, I.P., Projects PTDC/EGE-OGE/31246/2017 and UIDB/05037/2020.
Author information
Authors and Affiliations
Contributions
José Valente: Conceptualization; formal analysis and investigation; writing – original draft and preparation. Mário Augusto: Conceptualization; writing – review and editing; supervision. José Murteira: Methodology; writing – review and editing.
Corresponding author
Ethics declarations
Competing interests
The authors have no competing interests to declare that are relevant to the content of this article.
Additional information
Publisher’s Note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
Rights and permissions
Springer Nature or its licensor holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.
About this article
Cite this article
Valente, J., Augusto, M. & Murteira, J. Bargaining power and renegotiation of small private debt contracts. Ann Finance 18, 485–510 (2022). https://doi.org/10.1007/s10436-022-00413-y
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10436-022-00413-y