Referee Report on ”CEO compensation and Bank Loan Contract”

Paper Summary

The paper finds that bank CEO’s with more inside debt lend to safer borrowers and have
lower non performing loans. Loan contracts written by banks with CEOs with greater in-
side debt claims have concentrated syndicates, lower spread, larger maturity, less restrictive
covenants.

Comments on the analysis

• Overall Assessment : The paper’s analysis is well done. The conclusions are believable.
The tests carefully consider the various econometric issues and uses methods to address
the same. The two biggest issues are the following:

• Incremental Contribution

– The paper should make a better case of its incremental contribution. Anan-
tharaman et al (2013) show that debt of firms with higher CEO relative leverage
receive lower yield and face fewer covenants. The author(s) show that the loans
granted by banks with high bank CEO relative leverage also have lower yields
and face fewer covenants. Is this paper’s result then simply a restatement of the
same earlier result from the firm side? What is the economic mechanism behind
this matching / non matching of firms and banks due to the CEO inside debt
incentives (if it exists)?

– There are already a few papers in the literature that show bank CEO’s higher
inside debt predicts lower risk taking (Bennett et al (2015) and Srivatsav et al
(2018)). So making low risk loans with higher inside debt is certainly consistent
with these papers, but the author(s) have to do more (The stated contribution
number 2 on page 4 is invalidated by these papers. The current paper is not
the first to show lower risk taking. Why should it matter for the reader that

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 we see lower risk taking for loans in particular as opposed to acquisitions, for
example. These two papers are also not cited on page 5 in the discussion before
hypothesis 1 by the author(s)). Further recommend that author(s) exert some
effort in developing Hypotheses 2-5.

– Both of these issues cannot be fixed by mere rewriting. The author(s) need to
develop new results to enhance their incremental contribution. If done, this can
be an useful addition to the literature.

• Inconsistencies

– The author(s) find the following associations with inside debt: concentrated loan
syndicates (which encourage more intense loan monitoring due to greater risk of
the borrower as per Sufi (2005)). Yet, they also find lower spreads (indicating
lower risk) of the borrowers.But a lower risk firm implies a more diffuse syndicate
structure. Further, they also find lower covenants which indicates less incentive to
monitor (as per Rajan and Winton (1995)), which is inconsistent with both con-
centrated loan syndicate and lower spreads. These inconsistencies with the theory
must be confronted and explained. One way, could be to take both the borrower
screening (ex-ante) and borrower monitoring (ex-post) hypotheses seriously as
opposed to explaining everything through screening as done in the abstract).

– Longer maturity of loans is also inconsistent with Diamond (1989). The very good
quality firms receive short maturity loans (as do the very poor quality firms) in
his model. If the author(s) want to claim the bank’s clients in their sample are
very good quality (as they claim in the abstract) they need to reconcile this with
Diamond (1989) which has found support in other empirical literature.