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Small Business Economics

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01.04.2008

Lending to small businesses: the role of loan maturity in addressing information problems

verfasst von: Hernán Ortiz-Molina, María Fabiana Penas

Erschienen in: Small Business Economics | Ausgabe 4/2008

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Abstract

We investigate what determines the maturity of lines of credit to small businesses. Our results provide strong support for the hypothesis that shorter loan maturities serve to mitigate the problems associated with borrower risk and asymmetric information that are typical of small business lending. We find that maturity is shorter for firm owners that have poor credit histories, are older, and less experienced, and for firms that are more informationally opaque. Supporting the notion that collateral and maturity are substitute mechanisms in mitigating agency problems, we also find strong evidence that maturity increases with collateral pledges, that personal collateral is associated with longer maturities than business collateral, and that collateral types that better mitigate agency problems reduce the sensitivity of loan maturity to informational asymmetries and risk. Finally, while it is argued that relationship lending may mitigate information asymmetry, we find no relation between loan maturity and stronger firm-creditor ties.

Vorheriger Artikel Credit market failure intervention: Do government sponsored small business credit programs enrich poorer areas?

Nächster Artikel The Barriers to Growth in Ghana

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LOC may contain material adverse change clauses (MAC) that permit the bank to abrogate the commitment if the borrower's financial condition has changed substantially. However, in the same way as covenants, these clauses can only be contingent on verifiable characteristics of the borrower. In addition, Berger and Udell (1995) explain that because of reputation effects and lender liability laws, banks are reluctant to invoke these clauses except under very extreme circumstances.

Mester (1997) reports that the first to use scoring for small-business loans were large banks that had enough historical loan data to build reliable models (e.g., Wells Fargo, BankAmerica, Citicorp). Such credit scoring models found that the most important indicators of small-business loan performance were characteristics of the business owner rather than the business itself. For example, the owner’s credit history was a better predictor of performance than the net worth or profitability of the business.

While both arguments predict a positive association between maturity and collateral, they have opposite implications for the relation between collateral pledges and firm risk. In our analysis we provide some additional evidence that helps to empirically distinguish between these alternatives.

Their measures are the weighted-average maturity of the firm’s different types of debt outstanding (lines of credit, capital leases, mortgages, motor vehicle, and equipment loans), and the fraction of total debt that matures in more than one year.

While our hypotheses are based on the debt contracting literature, they test the implications of Flannery’s (1986) and Diamond’s (1991) signaling models for debt maturity choices. Flannery’s model predicts that debt maturity is an increasing function of borrower risk, and Diamond’s model predicts this relationship to be non-monotonic, with the safest and riskiest types issuing short-term debt and the intermediate risks issuing long-term debt. Our result of a negative relation between maturity and borrower risk (even after allowing for non-monotonicity) supports the debt contracting view.

The interest in small business finance in the US arises from the concern that the recent consolidation of the US banking industry could have a negative impact on the contract terms and availability of credit to small firms. Another objective of the NSSBF is to provide data to study whether small businesses owned by racial minorities are discriminated in lending markets.

The price conditions in a typical LOC contract include a borrower-specific markup over an economy-wide interest rate, and an up-front commitment fee. The non-price conditions include collateral requirements, and compensating balances.

To check whether this premise is correct we also run our regressions for the subset of other loan types reported in the NSSBF (capital leases, mortgages, motor vehicle loans, and equipment loans). As expected, our results indicate that the sensitivity of the maturity of these single purpose loans to risk and information asymmetry variables is very low compared to the lines of credit (results available from the authors).

We do not use the more recent 1998 nor the older 1987 surveys because they do not contain information about some variables that are important for our analysis (e.g., information on the declared used of the loan, depreciation expenses, and the number of employees devoted to R&D).

Gibbons and Murphy (1992) make a similar argument in the context of executive career concerns. They argue that as CEOs approach retirement their incentive to preserve their reputations diminishes.

These dummies allow for a non-monotonic effect of borrower risk on maturity.

Depreciation is also used to capture asset tangibility in Scherr and Hulburt (2001), and Barth et al. (2001). Deprec is a potentially noisy variable, since depreciation depends on accounting policy and different asset classes have different depreciation schedules. However, difference of criteria is minimized in our sample because all our firms are based in the US and most of them use the IRS method to determine the useful life of assets on their books. While there is discretion on the method of depreciation to be used, anecdotal evidence suggests that most firms use the straight-line method.

Noborrinst might also be a proxy of the firm’s credit risk, as more risky firms could be credit-constrained at their primary lender, and therefore may seek additional financing in other institutions. This generates the same prediction regarding maturity

While Degryse and Ongena (2005) argue that geographical proximity makes monitoring easier, Petersen and Rajan (2002) find that the importance of distance between borrower and lender in the US has decreased over time due to technological changes in information processing. This would predict no effect of Distance on maturity.

We examined the pair-wise correlations among the right-hand side variables and verified that our independent variables are not highly correlated. We also examined pair-wise correlations between our dependent variable and each of the independent variables in our empirical model, and obtained results that are consistent with the detailed multivariate regression analysis we report. Thus, we are confident that multicollinearity is not a problem in our regression analysis.

In unreported regressions, we also included a dummy variable for whether the loan has a personal guarantee or not. However, the guarantee dummy is not statistically significant, and does not affect any of the results we report. One interpretation for the lack of effect of personal guarantees on maturity is that, as opposed to collateral, they are a more general and weaker claim on personal wealth that does not involve liens to specific assets and thus are less effective in mitigating moral hazard problems. Another possible explanation is that most states in the U.S. have homestead acts that limit the creditor’s access to some personal assets in exercising guarantees, but do not take precedence over security interests in assets pledged as collateral (Avery et al. 1998).

Personal collateral includes personal real estate and other personal non-specified, and business collateral includes business real estate, business securities or deposits, equipment, accounts receivable, or other

Table 6 excludes the 40 observations corresponding to loans with unspecified types of collateral. Because the median owner delinquencies, firm delinquencies, and fees paid are zero, we replace them by three dummy variables Odelinq, Fdelinq, and Hasfees, that are equal to one when these variables take positive values.

Table 6 shows that collateral pledges are associated with more rather than less borrower risk and information asymmetry. This is consistent with the agency argument for collateral pledges and maturity, but not with the signaling argument. Thus, this supports our interpretation of the positive association between collateral and maturity as suggesting that collateral and maturity are substitute mechanisms that mitigate agency problems.

In practice personal bankruptcy exemptions also affect small corporations. Because when making loans to small corporations, lenders require that owners personally guarantee the loans, the legal distinction between corporations and their owners for purposes of the particular loan disappears for small corporations and puts the owner’s personal assets at risk to repay the loan.

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Titel: Lending to small businesses: the role of loan maturity in addressing information problems
verfasst von: Hernán Ortiz-Molina
María Fabiana Penas
Publikationsdatum: 01.04.2008
Verlag: Springer US
Erschienen in: Small Business Economics / Ausgabe 4/2008
Print ISSN: 0921-898X
Elektronische ISSN: 1573-0913
DOI: https://doi.org/10.1007/s11187-007-9053-2

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