Submitted by Mehwish Shehzadi

Reg no. mm123040

Sec 1

Submitted to Mr. Zaheer Abbas

 Summary of Article
In this research paper the author studied the resulting impact of poor performance on the
reputation of financial intermediary that have faced the bankruptcies at a very large scale. The
outcomes are going to be much precise when the insolvency from the borrower suggests
insufficient screening and monitoring by the controller. Though, the significance of such
insolvencies is not there among existing lead controllers on the syndication activity, but this
effect is seem to be weaker in the recent years due to which many of the lead controllers had
experience borrower insolvencies.

The job of screening and monitoring firms assigned to expert financial mediators i.e. banks or
underwriters by the investors. But there is a disadvantage to this job delegation that is it can
bring too much information confusion and motivational problems between investor and
mediator. By studying the function of reputation, the hypothetical literatures suggest that the
mediator concern on screening and monitoring can minimize the agency problems. But the poor
performance can cause bad reputation and economic loss for intermediary. This loss of
reputation can also lead the financial mediator to bear some cost, but this cost may differ across
every institution, depend on the current conditions of market.

This loss of reputation can lower the controllers’ ability to attract the more market participants
for the purpose of loan syndication activity. That’s why in this research paper this is referred to
as reputation hypothesis. Except from the loss of reputation, these insolvencies can also be the
reason to cause the damage and a great loss in the controller’s capital. The author has tested these
forecasts by studying and combining some relevant data sources.

But in this paper the author studied this loss of reputation and cost on the loan syndication
market. The practical approach of this paper is to examine the effects of “shocks” for a controller
on the syndication activity. The author has interpreted the controller’s reputation in the means of
market opponent of its instinctive ability to screening and monitoring the borrowers. But in case
of any uncertainty in controller’s performance or in screening and monitoring activities then it
can lead to a great loss of reputation and insolvencies among firms.
To find out controllers that have large insolvent borrowers, the author has generated dummy
variable that is “large bankruptcies”, this dummy variable is going to be one when insolvencies
from borrowers are going to exceeds from ten percent from the last two years. This ten percent
reduction can tolerate for predictable level of insolvencies that are not penalized by the market.

The main findings of this hypothesis are that controller who had experienced more insolvency by
the borrowers can maintain more loan of what has been arranged by him that can be up to 4.95
%. This evidence is dependable on the reputational hypothesis. The controllers concern to
maintain the reputation can lead to minimize the agency problems, the likely info and the
motivational problems in the loan organization market.

The uncertainty about the controller’s performance and ability can lead to a great loss in
reputation and insolvency. As discussed earlier the larger insolvencies can lead to the erosion of
controller’s reputation, but the controller can mitigate this by retaining a larger part of the loans
that are going to be arranged by him in the future. By retaining this fraction of loan a controller
just not enhance the motivation but can also perform as a more stronger indication for the
borrower to monitor and screening. “For a controller reputation the unexpected insolvencies can
lead to more danger rather than expected solvencies, because for the controller the previous are
more analytical of insufficient screening and monitoring. Although during the period of
economic agony these insolvencies should be much greater, and less informative about the
controller’s ability.

Thus these indicate that insolvencies always have a distinctive impact on the controller’s ability.
By studying the reputational hypothesis it has been predicted that these larger insolvencies can
also effect on the market participants, as it can on controller ability, future borrower and on the
loan report as well.

The second hypothesis that has been assumed in this research article is the “Alternate
hypothesis”, which states that these borrower insolvencies can also lead the controller to the
large monetary loss. The controllers are just not going to bear this loss but it can also lead to the
erosion of the relationships between the controller and insolvent firm. If a controller has to raise
the capital to lower the level of these insolvencies and, then there is a possibility that these
insolvencies can lessen the capital base for controller and thus the loan as well for the future.
These empirical tests were conducted to get an overtly control on the capital level so that a
distinction can be drawn between the reputation hypothesis and alternative hypothesis. The
author has obtained the data on individual loan agreements by following a time period of 2006
from Dealscan database. This database has provided the information of all larger and medium
sized firms on loan contracts. This represents the seventy percent of the research the rest of the
data has been collected directly from the borrowers and lenders. The loans can be financed by
individual lenders but can be by a group of lenders.

The database allows us to see the controller whenever loans are financed by a group of lenders.
So, it specifies that the lead arranger or controller can be used as a variable when the lender act
itself as a controller. In this research paper the author has used all these loans having one
controller variable. But for the multiple controllers or lead arrangers the author has used single
observation that is analogous to each controller.

The author of this research paper has also used the financial information on borrowers from the
Compustat database. By extracting this the author was able to run the best test and to got the best
results by the comparison of these two databases that have been used in this research paper.
Author has also used the financial information from bank holding companies. The most
important independent variable can be called as dummy variable is the larger insolvencies or
bankruptcies that are used in regression test.

Though to run the robustness, the author had performed the tests by using these insolvencies,
which can be called scaled insolvencies or bankruptcies. The empirical analysis of this paper
describes that the author has used a number of alternatives to classify these insolvencies as
expected or might be as an unexpected. The Lagged value of this analysis that the author has
used is large bankruptcies, and during the period from 2005 to 1990, bankruptcy information, our
regressions are limited to Loans during 1991 was in 2006.

Furthermore, the regression run in this research paper is usually based on the management of
borrower monetary characteristics, but these are only available in the Compustat database.
Various tests have been conducted to report statistics by using these variables of loans from a
time period of 1991-2006. Every result or observation depicts the loan. The test contains on the
two panels, panel A and panel B. Panel ‘A’ shows the entire sample while the panel B described
that data arise from the comparison of all subsamples, by using the key variable “large
bankruptcies”.

Each observation depicts one controller. A large number of discrepancies exist while testing the
loan amount, average is $272m and the median is $90m, the average has been found about 169
based on the method of LIBOR. While the maturity period of short term loan security is about 23
percent and the long term is about 16 percent. This level of discrepancy also has been found in
the borrower size. The value of large bankruptcies is about 0.07, which describes the portion that
has been investigated by the controller for the insolvencies of last period estimated about 7
percent.

To check the impact of larger insolvencies for loans by the controller, a multivariate scrutiny
method has been used by the author. This analysis has proved that a larger increase in lead
provision is going to happen when the number of insolvencies is going to rise. These results can
be checked through the panel data regression, which can be represented in the following
equational from.

Lead allocationl = β0+ β1*large bankruptciesj,t,-1+ β2+ Xi+ β3* Xl+ β4* Xj+ μt+ μi

Where:

L= denotes the loan,

I, J= denotes the borrower and controller correspondingly

T= represents the loan initiated year

A question has been raised from these tests that “what is the impact of these insolvencies on lead
provisions and group activities”? Whether this impact continues to be there for more than one
year? The reputation hypothesis suggests that the controller who is engaged in the activities of
monitoring and controlling is being hesitant to participate in the larger group activities to avoid
from insolvencies. This can arise a great cost that might be bear by the controller. But it is not
always possible for market participants to avoid from the lead arranger.

The robustness test is done by author using a variable ‘large bankruptcies’. The purpose to use
this dummy variable is to specify or categorize those controllers who never themselves faced any
large insolvencies however closest in means of the loan syndication to a controller that have
gone through greater number of insolvencies throughout the year. Dummy variable ‘pre large
insolvencies’ is used to classify controllers’ state in the year before the occurrence of large
insolvencies. The loans relating duplicate interactions between the borrower and the lead
arranger is specified with dummy variable named ‘repeat’.

There arises a question, if large insolvencies classify controller that let somebody borrow from
risky firms?

We can assess that it’s improbable to be the case because controllers past loans have nothing
much to do with the increase in lead provision subsequently greater insolvencies. The same
could be enlightened in another way by simply examining if there were any ‘anomalous or
atypical’ greater loan risks taken in the year prior to they faced insolvencies? To examine the
scenario, the variable ‘lead allocations’ is used as proxy for risk as it imitates the risks well
known by lenders.

Controllers, prior to the year they faced huge insolvencies are identified with the dummy
variable ‘pre large bankruptcies’. This assessment is then repeated by replacing ‘large
insolvencies’ with ‘pre large insolvencies’. Our results provide large insolvencies lend to risky
firms that identified lead arrangers are due to the fact, pre large insolvencies, then we should
expect affirmative and noteworthy coefficient. Unimportant coefficient on huge insolvencies
already specified, but does not support this alternative justification.

Are our results of large bankruptcies are due to changes in the credit profile? Again, the
relationship between borrower included dummy variable that categorizes loans: To check and
run the test for this possibility, we repeated calculations later than including two new variables:
‘repeat’ dummy variable to classify the loans that are involving in duplicate associations between
the borrower and controllers, and the dealing term ‘huge insolvencies’.
 In this research paper the author has examined the few factors that affect on controller’s
performance and can lead to experience greater insolvencies such as size or the relationships
with the market participants and other controller’s. This assumption provides a new approach in
reputation hypothesis that how it could work in loan market. The author has examined the panel
regression in the following form.

Log (1+Loans together)jkt= β0+ β1* [large bankruptcies j,t−1 *X k,t−1 ] +β2* [large bankruptcies
j,t−1 * [1−X k,t−1 ]]+β3* Xj+ μjk+ μt,

Loan together Jkt= represents the number of syndicated loans by controllers. The Log (1+Loans
together) is used as a measure that movement that is held between the controller and market
participant. Author has computed the value of one in loan together to avoid it to acquire the value
of zero. This test is used because the Dealscan database cannot present the data comprehensively.

The final test conducted by the author represents the impact of larger insolvencies on borrowers.
To run the regression test a number of borrowers and loan distinctiveness are taken as dependent
variables. As a result, the research paper can be summarized as the author has used the loan
syndication market for testing to check that the impact of reputation loss whether it is costly or
not, and the level of variance across different institutions.

The empirical analysis has shown that the purpose was to study the shocks that can be arising as
a result of reputation loss on controller. By studying the literature review and many other
theories based on the reputation and its effectiveness it has been examined by the author that the
findings of this paper are totally different from others as they are just focusing on the
effectiveness of the reputation.

But this paper provides a wide study on the shocks that emerge as a result of reputation loss. As a
result it has been found that the large bankruptcies can lead to the loss of controller’s
performance. Unexpected insolvencies leave very strong effect on the controller’s performance
and can lead to the insufficient function of monitoring and screening activities.

A remarkable finding of this paper is that it is not mandatory that every controller who is
suffering from the poor performance is due to the loss of reputation. But it has been found that
the borrower insolvencies place a very minute impact on the controller’s activities. These finding
points a limitation on reputation hypothesis.