Disclosure and the Loan Spread on Private Debt

Companies that consistently make detailed, timely, and informative disclosures face lower costs of public equity and debt capital. The study reported here investigated whether such companies also face lower interest costs on private debt contracts. Examination of a sample of 173 new private debt issues during the 1989–93 period suggests that, after company- and loan-specific factors and market conditions have been controlled for, loan spreads are negatively associated with a measure of companies' overall disclosure quality. That is, companies with consistently high ratings for voluntary disclosures pay lower interest on their private debt (bank loan) contracts. Companies that consistently make detailed, timely, and informative disclosures face lower costs of public equity and debt capital. The study reported here investigated whether such companies also face lower interest costs on private debt (bank loan) contracts. We examined a sample of 173 new private debt issues during the 1989–93 period. The loan spread was the reported spread over LIBOR, the U.S. Federal Reserve prime rate, or CD rates obtained from the DealScan database compiled by the Loan Pricing Corporation. Our proxy for the overall disclosure quality of companies was obtained from volumes of the Corporate Information Committee Report (CIC Report) published annually from 1976 through 1996 by the Association for Investment Management and Research (now CFA Institute). Our findings suggest that, after company- and loan-specific factors and market conditions have been controlled for, loan spreads are negatively associated with a measure of companies' overall disclosure quality. That is, companies with consistently high ratings from analysts for the quality of the companies' voluntary disclosure pay lower interest on their private debt contracts. The negative relationship between loan spreads and the aggregate disclosure metric was quite large—a 1 point increase in the composite disclosure score was related to a 1.62 bp lower loan spread. Thus, holding all other factors constant, the benefit of disclosure can be crudely approximated. The highest and lowest composite disclosure scores (out of a possible 100) observed in our sample were 95.85 and 38.30, respectively, for a disclosure score differential of 57.55. Such a differential would result in annual interest cost savings of 0.93 percentage point annually. Assuming that the company with the highest disclosure score held an average-sized loan for this period ($624.67 million) and with other factors that affect loan pricing held constant, the company would have saved, on average, approximately $5.8 million annually compared with the company with the lowest disclosure score. Overall disclosure scores were broken into three categories—the quality of the company's disclosure (voluntary and required disclosures) in annual reports and other required published material, the quality of the company's disclosure provided in quarterly reports and other nonrequired published material (such as proxy statements), and the quality of the company's disclosures made to financial analysts. The loan spread was negatively associated with all disclosure subcategory scores, but the result was strongest for voluntary disclosures in required annual reports. Our findings suggest that financial intermediaries, which one can argue have better monitoring abilities than public debtholders have and have access to private information about companies they lend to, nevertheless rely on the quality of a company's disclosures and incorporate this information in their default-risk estimates. Companies that are rated favorably on the basis of their disclosure quality enjoy a lower interest on their private loans, possibly because banks believe these companies are unlikely to be withholding adverse financial information. This study also extends prior research on the effects of disclosure quality on the cost of equity capital and on the interest cost of public debt issues. Our analysis is relevant from a company perspective for corporate governance and capital structure decisions because private debt constitutes the bulk of corporate credit. Our results also shed empirical light on the nature of private loan contracting and pricing, which is an important area of academic research.