Description: In a 2004 study, Harvey, Lin and Roper argue that debt makers with a commitment to monitoring can create value for outside shareholders whenever information asymmetry and agency costs are pronounced. I investigate Harvey, Lin and Roper's claim for bank loans by empirically testing the effect of information asymmetry and direct agency costs on the abnormal returns of the borrowers' stock around the announcement of bank loans. I divide my study into two main sections. The first section tests whether three proxies of the direct agency costs of equity are equally significant in measuring the direct costs associated with outside equity agency problems. I find that the asset utilization ratio proxy is the most statistically significant proxy of the direct agency costs of equity using a Chow F-test statistic. The second main section of my dissertation includes and event study and a cross-sectional analysis. The event study results document significant and positive average abnormal returns of 1.01% for the borrowers' stock on the announcement day of bank loans. In the cross sectional analysis of the borrowers' average abnormal stock returns, I find that higher quality and more reputable banks/lenders provide a reliable certification to the capital market about the low level of the borrowers' direct agency costs of equity and information asymmetry. This certification hypothesis holds only for renewed bank loans. In other words, in renewing the borrowers' line of credit, the bank/lender is actually confirming that the borrower has a low level of information asymmetry and direct costs of equity. Given such a certificate from the banks/lenders, shareholders reward the company/borrower by bidding the share price up in the capital market.
Date: December 2006
Creator: Hijazi, Bassem