The Determinants of Upfront Fees: Evidence from Chinese Debt Market
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In this paper, we investigate the effects of information transparency and lender protection on the lending premium of Chinese firms. The lending premium is reflected in the front-end payments. In the multivariate equation as well as the simultaneous equation model, more opaque Chinese borrowers, i.e. unrated and/or not listed borrowers, pay higher premium. Banks and other private lenders charge higher upfront fees to control potential adverse selection and moral hazard problems. While we find a strong negative relationship between upfront fees and lender protection proxies assuming loan spread is exogenous, the relationship becomes positive when they are modeled endogenously. This result is consistent with so-called "the observed risk hypothesis". Also when we model upfront fees and spread endogenously, the coefficient of loan maturity variable becomes significantly negative. Our results imply that, as Dennis et al. (2000) mention, simultaneous treatment of loan contract variables is necessary in order to avoid biases resulting from model specification.
Abstract
In this paper, we investigate the effects of information transparency and lender protection on the lending premium of Chinese firms. The lending premium is reflected in the front-end payments. In the multivariate equation as well as the simultaneous equation model, more opaque Chinese borrowers, i.e. unrated and/or not listed borrowers, pay higher premium. Banks and other private lenders charge higher upfront fees to control potential adverse selection and moral hazard problems. While we find a strong negative relationship between upfront fees and lender protection proxies assuming loan spread is exogenous, the relationship becomes positive when they are modeled endogenously. This result is consistent with so-called "the observed risk hypothesis". Also when we model upfront fees and spread endogenously, the coefficient of loan maturity variable becomes significantly negative. Our results imply that, as Dennis et al. (2000) mention, simultaneous treatment of loan contract variables is necessary in order to avoid biases resulting from model specification.
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