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Loan Officer Specialization and Credit Defaults

Michael Goedde-Menke , Peter-Hendrik Ingermann

PII: S0378-4266(23)00272-8
DOI: https://doi.org/10.1016/j.jbankfin.2023.107077
Reference: JBF 107077

To appear in: Journal of Banking and Finance

Received date: 2 May 2022

Accepted date: 22 December 2023

Please cite this article as: Michael Goedde-Menke , Peter-Hendrik Ingermann , Loan Of-
ficer Specialization and Credit Defaults, Journal of Banking and Finance (2023), doi:
https://doi.org/10.1016/j.jbankfin.2023.107077

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 Loan Officer Specialization and Credit Defaults

Michael Goedde-Menkea,* and Peter-Hendrik Ingermanna

a
Finance Center Münster, University of Münster, Germany

This version: December 18, 2023

Abstract: This paper shows that industry specialization of loan officers facilitates monitoring
synergies and lowers credit default rates of small- and medium-sized enterprises. We exploit a
wave of early loan officer retirements as a quasi-natural experiment, in which the resulting
borrower reallocations changed the industry specialization levels of the remaining loan officers.
In a difference-in-differences analysis excluding all reallocated borrowers, we find that a negative
shock to loan officer specialization increases default rates due to an inferior production of default
risk information and excessive loan growth. A positive shock to loan officer specialization
generates opposite effects. Our results suggest that loan officers can exploit industry specialization
and related monitoring synergies to improve lending decisions and thereby contribute to lowering
credit default rates in the bank’s borrower portfolio.

JEL classification: G21; G33

Keywords: Industry specialization; Credit default rates; Soft information production; Loan
officers; Monitoring synergies

*
Corresponding author: Michael Goedde-Menke, Finance Center Münster, University of Münster, Universitätsstraße
14-16, 48143 Münster, Germany. Phone: +49 (0) 251 83 22027. E-mail: michael.goedde-menke@uni-muenster.de.
Declarations of interest: none.
Abstract: This paper shows that industry specialization of loan officers facilitates monitoring
synergies and lowers credit default rates of small- and medium-sized enterprises. We exploit a
wave of early loan officer retirements as a quasi-natural experiment, in which the resulting
borrower reallocations changed the industry specialization levels of the remaining loan officers.
In a difference-in-differences analysis excluding all reallocated borrowers, we find that a negative
shock to loan officer specialization increases default rates due to an inferior production of default
risk information and excessive loan growth. A positive shock to loan officer specialization
generates opposite effects. Our results suggest that loan officers can exploit industry specialization
and related monitoring synergies to improve lending decisions and thereby contribute to lowering
credit default rates in the bank’s borrower portfolio.

JEL classification: G21; G33

Keywords: Industry specialization; Credit default rates; Soft information production; Loan
officers; Monitoring synergies

2
1. Introduction

Monitoring is one of banks’ core functions (Diamond, 1984; Ramakrishnan and Thakor, 1984).

Because small- and medium-sized enterprises (SMEs) often provide only little “hard” information

(e.g., financial statements), banks need to produce, process, and transmit “soft” information (e.g.,

opinions) to effectively monitor these informationally opaque borrowers.1 This paper studies the

production and processing of soft information at the loan officer level.2

Specifically, we explore the role of loan officer industry specialization and its impact on the

credit default rates of SME borrowers. Loan officer specialization is important with respect to the

production and processing of soft information because the structure (degree of specialization) of

the assigned borrower portfolio determines a loan officer’s possibility to exploit positive

monitoring synergies. First, higher specialization levels facilitate more segment-specific

information recycling across borrowers (Boot and Thakor, 2000). This specialization benefit arises

because the likelihood that new information acquired in monitoring one borrower is transferrable

to others increases for borrowers with similar characteristics (Chan et al., 1986; Stanton, 2002;

Jiang and Li, 2022). Second, more specialized loan officers gain better insight into the respective

borrower’s industry by monitoring a larger group of its industry peers. In theory, higher industry

specialization therefore increases monitoring effectiveness, resulting in enhanced loan repayment

probabilities and ultimately lower credit default rates (Winton, 1999; Boot and Thakor, 2000).

1
Liberti and Petersen (2019) characterize soft information as information that is expensive to produce, challenging to
store, and difficult to pass on to other individuals in an organization.
2
Prior research has focused on the transmission of soft information within banks (Stein, 2002; Alessandrini et al.,
2009; Liberti and Mian, 2009; Canales and Nanda, 2012; Agarwal and Hauswald, 2016).

1
 To the best of our knowledge, we are the first to empirically test this hypothesis at the (typically

unobserved) loan officer level.3 We thereby can explore the impact of industry specialization on

loan performance at the very same level that determines the production of soft information and

hence the effectiveness of the monitoring process.

Our proprietary data set is provided by a German bank and contains monthly information on

the bank’s entire borrower portfolio and loan officer-borrower assignments from 2006-2012. This

enables us to construct borrower portfolios at the loan officer level and to measure loan officer

industry specialization as a function of monitoring time and industry expertise. Our measure is

based on a conceptual framework and captures the precision of industry-specific, default relevant

information that loan officers have at their disposal.

Within our sample period, the bank launched an early retirement program for its loan officers

to reduce labor costs, which permanently reduced its monitoring workforce by about 30% in one

year (7/2007-7/2008). This downsizing event induced as-if random borrower reallocations from

the retiring loan officers to the remaining loan officers, changing the industry specialization levels

of the latter. Some borrowers are exposed to a substantial negative change in loan officer industry

specialization (negative shock; -14.9% on average), whereas others exhibit a strongly positive

change (positive shock; +16.5% on average) or no sizeable change at all. We utilize this quasi-

natural experiment and employ a difference-in-differences approach to identify the impact of loan

officer industry specialization on the credit default rates of SMEs.

We compare the difference in default rates before and after the reallocation period between

borrowers who experience a shock to loan officer specialization and borrowers whose loan officer

3
Previous studies examined the role of industry specialization at the bank level (e.g., Acharya et al., 2006; Berger et
al., 2010; Tabak et al., 2011; Jahn et al., 2016; Berger et al., 2017; De Jonghe et al., 2020; Beck et al., 2022; Jiang and
Li, 2022; see Section 5.3 for a detailed discussion).

2
industry specialization remains largely unaffected. To strengthen the accuracy of our identification

strategy, we only explore credit default rates among SME borrowers who never switched loan

officers. The exclusion of borrowers after a loan officer turnover is crucial for two reasons. Loan

officer turnovers represent disruptive events in the bank-borrower relationship, which tend to

increase default risk (Uchida et al., 2012; Drexler and Schoar, 2014) and represent an obvious

confounder in the case of reassigned borrowers. In addition, it is impossible to unambiguously

attribute the responsibility for a credit default to a specific loan officer if multiple officers are

involved in the monitoring process (Hertzberg et al., 2010). Only considering borrowers who are

monitored by the same loan officer before and after the reallocation period also enables us to

identify monitoring as driver of our results. As none of the borrowers are screened after the

reallocation period, we can rule out a change in screening efficiency as an alternative explanation.

We find that a shock to loan officer industry specialization affects default rates of SME

borrowers. Borrowers who are exposed to a negative specialization shock display a stronger

increase in average monthly default rates than unexposed borrowers (about +11 basis points).

Positively shocked borrowers exhibit a comparatively lower increase in default rates

(about -8 basis points). This pattern holds regardless of whether continuous specialization changes

or group comparisons are considered.

To test whether differences in monitoring effectiveness can explain our results (information

channel), we analyze the informational value of internal credit rating changes for predicting post-

reallocation borrower defaults. If loan officers adjust ratings based on inferior (superior)

information, they should be less (more) valuable for predicting defaults. We indeed find that the

informational value of rating changes is smaller for borrowers who experience a negative shock to

3
loan officer industry specialization (about -27%), while it is larger for borrowers exposed to a

positive shock (about +41%).

Since inferior or superior default risk information does not in and of itself produce credit

defaults, we explore the corresponding lending decisions (lending channel). We find that

borrowers who are exposed to a negative specialization shock exhibit significantly stronger loan

growth (about +43%). A positive shock is associated with a smaller increase in loan volumes

(about -55%). As neither the stronger nor the weaker loan growth is accompanied by differences

in credit pricing or collateral demand changes, we characterize these lending behaviors as

excessive and conservative, respectively. Thus, a negative shock to loan officer industry

specialization increases credit default rates due to excessive lending induced by an inferior

production of default risk information. A positive specialization shock reduces default rates due to

conservative lending induced by superior default risk information.

Our findings are robust to different research design choices and regression specifications.

Because the same loan officer can monitor both exposed and unexposed borrowers, we can control

for loan officer-by-time fixed effects (in addition to industry-by-time, region-by-time, and size-

by-time fixed effects), ruling out time varying differences in loan officer characteristics as

explanation for our results. The within loan officer perspective furthermore allows us to attribute

our findings to the specialization shock rather than to a change in loan officer workload (average

“busyness”), because the latter is identical for exposed and unexposed borrowers at the loan officer

level. Combined with the exclusion of reallocated borrowers, it also mitigates any concerns related

to characteristics of the inherited borrowers and retired loan officers for the same reason.

We ensure the appropriateness of our identification strategy by inspecting the covariate balance

across borrower groups, applying propensity score matching, and confirming parallel pre-

4
treatment trends by means of placebo regressions. We further rule out that our results are driven

by an asymmetric change in monitoring intensity (“attention”) for exposed and unexposed

borrowers or evergreening.

Our study contributes to the literature as follows: First, knowing the bank’s loan officer-

borrower assignments allows us to examine the impact of industry specialization on loan

performance at the loan officer level, i.e., the typically unobserved organizational layer which

determines a bank’s monitoring effectiveness. We provide robust empirical evidence that loan

officer industry specialization significantly affects the default risk of SME borrowers.

Second, we identify differences in the quality of the produced default risk information as the

underlying channel through which loan officer industry specialization affects default rates. Thus,

we provide support for the common assumption that industry specialization derives its power from

facilitating a superior information transfer across monitored borrowers (e.g., Boot and

Thakor, 2000; Jiang and Li, 2022). Our results indicate that loan officers successfully exploit

positive monitoring synergies in their lending decisions and thereby contribute to lowering credit

default rates in the bank’s borrower portfolio. Loan officer specialization therefore facilitates

informational synergies that improve a bank’s monitoring, a benefit previously documented for

cross-products (Hibbeln et al., 2020) and account activity (Norden and Weber, 2010).

Third, our findings emphasize that a substantial part of credit risk (borrower default risk) is

endogenous with banks’ quality of information production (monitoring). Hence, credit risk in bank

lending is to some extent man-made. This insight is not entirely new, though especially important

in the age of Fintech where many business models (and studies) assume that borrower risk is

exogenous and quantifiable like metrics in natural sciences. We show that a bank’s organizational

choices regarding the structure of the assigned borrower portfolios and the resulting industry

5
specialization of their loan officers significantly affect credit default rates. Targeting higher loan

officer specialization therefore extends the ability of banks to proactively reduce their exposure

with respect to borrower defaults beyond carefully designed loan officer incentives and decision

rights (Liberti and Mian, 2009; Qian et al., 2015; Berg, 2015; Cole et al., 2015; Liberti, 2018;

Agarwal and Ben-David, 2018; Berg et al., 2020), loan officer rotation schedules (Scott, 2006;

Hertzberg et al., 2010; Uchida et al., 2012; Drexler and Schoar, 2014; Canales and Greenberg,

2016; Bhowal et al., 2021), as well as loan officer training and recruiting programs (Beck et al.,

2013; Nakamura and Roszbach, 2018; Brown et al., 2020).

The remainder of this paper is organized as follows. Section 2 outlines our conceptual

framework. In Section 3, we provide the institutional background of our study and explain our

identification strategy. We describe our data and methodology in Section 4 and report results in

Section 5. Section 6 concludes.

2. Conceptual framework

In this section, we develop a conceptual framework to illustrate how loan officers benefit from

industry specialization. Key to the expected increase in monitoring effectiveness and lower default

rates are information gains due to specialization. They arise because borrowers do not only convey

information about their own quality (firm signal), but also about the industry they belong to

(industry signal). Both signals are important for loan officers to form a precise estimate about a

borrower’s default risk. However, only the latter is relevant for the synergistic gains across

borrowers within the same industry, as the firm signal is assumed to be entirely borrower specific.

Therefore, we focus on the conveyed industry signal in our framework.

Loan officers are required to extract the borrower-conveyed signals through evaluating hard

information (e.g., financial statements) and soft information (e.g., borrower’s management quality

6
and firm strategy). Since borrowers need to contractually provide hard information to the bank,

which is typically evaluated using standardized, bank-wide algorithms, benefits to loan officer

specialization are mainly associated with the production of soft information through monitoring.

In our framework, a loan officer’s ability to extract a more precise (complete) industry

signal from borrower 𝑖 in industry 𝐼 depends on, first, the time 𝜏𝑖 a loan officer spends on

monitoring the respective borrower and, second, the expertise 𝒳𝐼 a loan officer has with respect to

the borrower’s industry. We assume a simple effort allocation model where loan officers distribute

their time equally among all 𝑁𝐿𝑂 borrowers in their portfolio, so monitoring time 𝜏𝑖 per borrower
1
is 𝑁 . Loan officer expertise 𝒳𝐼 is expected to increase in 𝑁𝐿𝑂,𝐼 , the number of borrowers a loan
𝐿𝑂

officer monitors in the respective industry. We scale this number by the maximum number of

borrowers that is monitored by any of the bank’s 𝑘 loan officers in that industry. This ensures that

both variables, 𝜏𝑖 and 𝒳𝐼 , are measured on the same scale (ranging from 0 to 1). The precision of

the industry signal extracted by the loan officer can then be defined in its simplest form as:

1 𝑁𝐿𝑂,𝐼
𝑆̂
𝐿𝑂,𝐼,𝑖 = 𝜏𝑖 ∙ 𝒳𝐼 ∙ 𝑆𝐼,𝑖 = ∙ ∙ 𝑆𝐼,𝑖 ,
𝑁𝐿𝑂 max {𝑁 ∈ {1, … , 𝑘}} (1)
𝐿𝑂,𝐼 : 𝐿𝑂

where 𝑆𝐼,𝑖 is the basic industry information extractable from borrower 𝑖 in industry 𝐼, and the

preceding factors determine the ability of the loan officer to extract this industry information.

Hence, a hypothetical loan officer monitoring only a single borrower (first factor equals 1) with

maximum industry expertise (second factor equals 1) would be able to extract 100% of a

borrower’s industry signal (𝑆̂

𝐿𝑂,𝐼,𝑖 = 𝑆𝐼,𝑖 ). If a loan officer has less time to monitor the borrower or

less expertise regarding the borrower’s industry, only a fraction of the industry signal will be

uncovered.

7
 To aggregate a loan officer’s soft information production at the industry level ( 𝑆̂
𝐿𝑂,𝐼 ), we sum

up all industry signals that a loan officer extracts within an industry. We account for the decreasing

marginal utility of additional (industry) information by taking this sum to the power of 𝛼 (with

0 < 𝛼 < 1).

𝑁𝐿𝑂,𝐼 𝑎 𝑁𝐿𝑂,𝐼 𝑎
1 𝑁𝐿𝑂,𝐼
̂
𝑆 ̂
𝐿𝑂,𝐼 = ( ∑ 𝑆𝐿𝑂,𝐼,𝑖 ) = ( ∑ ∙ ∙ 𝑆𝐼,𝑖 ) . (2)
𝑁𝐿𝑂 max {𝑁 ∈ {1, … , 𝑘}}
𝑖=1 𝑖=1 𝐿𝑂,𝐼 : 𝐿𝑂

By assuming that all borrowers within an industry contribute equally to the set of industry

information, we can set the borrower-conveyed industry signal 𝑆𝐼,𝑖 to 1 and simplify Equation 2

to:
𝑁𝐿𝑂,𝐼 𝑎
1 𝑁𝐿𝑂,𝐼
̂
𝑆𝐿𝑂,𝐼 = ( ∙ ∙ ∑ 1)
𝑁𝐿𝑂 max {𝑁 ∈ {1, … , 𝑘}}
𝐿𝑂,𝐼 : 𝐿𝑂 𝑖=1

𝑎
(3)
𝑁𝐿𝑂,𝐼 𝑁𝐿𝑂,𝐼
=( ∙ ) .
𝑁𝐿𝑂 max {𝑁 ∈ {1, … , 𝑘}}
𝐿𝑂,𝐼 : 𝐿𝑂

The precision of industry-specific, default relevant information therefore largely depends on

𝑁
the product of the monitoring time a loan officer spends in an industry ( 𝑁𝐿𝑂,𝐼 ) and the corresponding
𝐿𝑂

industry expertise. We furthermore assume 𝛼 = 0.5 to ensure that the function exhibits constant

returns to scale (exponents of both factors sum up to 1).4 We refer to the result of this functional

relationship as loan officer industry specialization.

0.5 0.5
̂
𝑆𝐿𝑂,𝐼 = (𝑀𝑜𝑛𝑖𝑡𝑜𝑟𝑖𝑛𝑔 𝑡𝑖𝑚𝑒𝐿𝑂,𝐼 ) ∙ (𝐸𝑥𝑝𝑒𝑟𝑡𝑖𝑠𝑒𝐿𝑂,𝐼 ) = 𝐿𝑜𝑎𝑛 𝑜𝑓𝑓𝑖𝑐𝑒𝑟 𝑖𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑠𝑝𝑒𝑐𝑖𝑎𝑙𝑧𝑖𝑎𝑡𝑖𝑜𝑛 . (4)

4
Constant returns to scale imply that the set of extracted industry information increases by the same proportional
change as all factors change. For example, if both a loan officer’s monitoring time and industry expertise increase
by 10%, the set of extracted industry information also increases by 10%.

8
 An increase (decrease) in loan officer industry specialization implies that loan officers have

more (less) precise default-relevant industry information at their disposal. More (Less) precise

industry information, in turn, should increase (decrease) monitoring effectiveness and ultimately

lead to lower (higher) credit defaults (cf. Winton, 1999; Boot and Thakor, 2000). We are going to

test these hypotheses in the analyses that follow.

3. Institutional background and identification strategy

3.1. Background

To explore the impact of loan officer industry specialization on credit default rates, we obtained

the entire borrower portfolio of a German bank, covering the period from 1/2006-12/2012. The

bank predominantly caters to SME borrowers from ten different industries and private individuals.

Studying the impact of industry specialization on credit defaults for SMEs is a suitable setting as

information asymmetries are particularly strong for this group of borrowers (Petersen and

Rajan, 1994; Strahan and Weston, 1998; Minnis and Sutherland, 2017), aggravating the

importance of monitoring. The bank operates a network of branches in different regions and the

loan officers with a focus on monitoring SME borrowers are located in regional headquarters. In

1/2006, the bank employed about 105 such loan officers. The median SME borrower is monitored

by a loan officer who handles about 100 firms. A loan officer’s compensation is almost entirely

determined by a fixed salary and does not penalize bad loan outcomes.

Due to the regional orientation of the bank, loan officers mainly cater to borrowers who are

located in the same region as their headquarter is to keep bank-borrower distances short. The

median distance between a borrower and the responsible loan officer is about 4.6 miles (7.5 km)

9
or about 14 minutes by car. New customers are generally assigned to loan officers based on

availability and workload considerations, which has two important consequences.

First, the largely random development of the borrower portfolio makes it difficult for loan

officers to specialize in only a few industries. In 1/2006, the median borrower is monitored by a

loan officer who is responsible for eight different industries. Given that there are only few utilities

in our sample (0.8%), the median borrower’s loan officer monitors firms from almost all industries

(agriculture, utilities, manufacturer, construction, retail, logistics, finance/insurance, housing,

other services, non-profit).

Second, considering potential workload imbalances when assigning new borrowers to loan

officers results in similar borrower portfolios in terms of size. We calculate the Gini coefficient

(Pyatt, 1976) as a measure of borrower number inequality across loan officers within a headquarter

and obtain a value of 0.13. As a Gini coefficient of zero indicates equality, our value is commonly

viewed as describing a characteristic with low inequality across the underlying population

(Haidich and Ioannidis, 2004). Hence, the loan officers in our sample benefit from balanced

workloads at the expense of industry specialization. This can also be observed for the borrower

reallocation that represents the cornerstone of our identification strategy.

3.2. Identification

Key to our identification strategy is a bank-wide event that strongly affected the number of loan

officers employed by the bank. In July 2007, the bank launched an early retirement program that

allowed employees to retire early while facing only limited reductions in their pensions. Such

offers were typically subsidized by the federal government for employees who were already close

to the regular retirement age of 65. Even though the government supported program (which ended

in 2009) aimed at replacing early retirees by new employees, firms often used it to permanently

10
reduce the workforce and cut labor costs, i.e., to downsize. The bank that provided our data offered

the opportunity of early retirement to its eligible employees (i.e., those who were close to the legal

retirement age) and many of them took the offer. The bank was highly interested in the success of

the program to achieve its targeted reduction in labor costs. Most early retirements took place at

the end of 2007 but continued until the middle of 2008. Panel A of Figure 1 illustrates the

consequences for the number of loan officers employed by the bank, showing a decline of 30%

within just one year (7/2007-7/2008). As a result, borrowers had to be reallocated from the retiring

to the remaining loan officers. Panel B of Figure 1 illustrates this downsizing-induced workload

change. The average number of monitored borrowers per loan officer increased by about 20%

compared to the respective number in the month before the early retirement program was launched.

(Insert Figure 1 about here)

To maintain the bank’s regional orientation, borrowers from a retiring loan officer were usually

reallocated to other loan officers within the same headquarter. Moreover, the reallocations were

guided by an attempt to further enhance the workload balance across loan officers (Gini coefficient

improved to 0.07) rather than to improve industry specialization. The average borrower portfolio

reallocated to a loan officer comprised 4.7 different industries, causing an increase in the number

of industries the median borrower’s loan officer is responsible for to nine. Due the bank’s lack of

focus on specialization in the reallocation process, the median borrower’s loan officer industry

specialization only slightly changed (from 32.4% to 33.5%). In addition, loan officer incentives

remained unchanged after the reallocation. Loan officer compensation continues to be almost

entirely determined by a fixed salary and does not penalize bad loan outcomes.

We split our sample in three time periods: the pre-reallocation period (1/2006-6/2007), the

borrower reallocation period (7/2007-7/2008), and the post-reallocation period (8/2008-12/2012).

11
Loan officer industry specialization is calculated as derived in our framework in Section 2.5 Our

specialization measure considers both a loan officer’s monitoring time within an industry (based

on the portfolio share an industry represents) as well as industry expertise (based on the number

of borrowers in an industry). The borrower reallocations can affect loan officer industry

specialization in two ways: First, the composition of the reallocated borrower portfolio can change

the portfolio share an industry represents. The portfolio share increases (decreases) if the

proportion of borrowers in the reallocated portfolio is larger (smaller) than in the loan officer’s

portfolio before the reallocation. The portfolio share remains unchanged if both proportions are

identical. Second, the reallocations can change the number of borrowers in an industry and thereby

alter a loan officer’s industry expertise. The change in specialization that a loan officer exhibits in

an industry during the reallocation period depends on both factors.

We calculate the change in loan officer industry specialization by first subtracting the

specialization level in the last month of the pre-reallocation period from the specialization level in

the first month of the post-reallocation period. To facilitate an easier interpretation of this

difference, we then scale it by the average loan officer industry specialization within the bank in

the last month of the pre-reallocation period (0.358).6 For example, a difference in loan officer

5
The simple effort allocation model assumed for deriving the underlying framework is plausible in our setting. The
loan officers in our sample likely share monitoring efforts equally across borrowers because they lack incentives to
monitor some borrowers more than others. Their compensation is almost entirely determined by a fixed salary and
does not penalize bad loan outcomes. The fact that observed monitoring activities (inferred from credit term revisions;
Cerqueiro et al., 2016) exhibited by borrowers throughout the sample period do not significantly differ from those
expected under a uniform distribution of monitoring efforts, further supports this notion.
6
Note that this scaling has no impact on the ordering of borrowers with respect to the magnitude of the experienced
change in loan officer industry specialization because the divisor is identical for all borrowers. Scaling with a loan
officer’s average or even industry specific pre-reallocation specialization level would not preserve the ordering.

12
industry specialization of -0.072 (Pre: 0.272; Post: 0.200) corresponds to a change in loan officer

specialization of about -20% (-0.072/0.358).

The change in loan officer specialization indicates how the precision of a loan officer’s default-

relevant information regarding an industry has been affected by the borrower reallocations. A

negative [positive] change implies that loan officers have less [more] precise industry information

at their disposal. Less [More] precise industry information is expected to decrease [increase]

monitoring effectiveness and ultimately lead to higher [lower] credit default rates.

When calculating the change in industry specialization for the loan officers in our sample, we

further address two potential endogeneity concerns: First, to rule out that our measure is affected

by changes in the loan demand, we exclude all borrowers who are entirely new to the bank or

leaving it for good during the reallocation period. Second, to avoid that the change in specialization

is affected by a potential decline of the respective industry, we exclude (the few) borrowers who

default during the reallocation period and are transferred to another loan officer before its end.

Our identification strategy builds on a comparison of default rate differences before and after

the reallocation period between borrowers who vary in the degree to which they experienced a

shock to loan officer specialization due to the downsizing event. To strengthen the accuracy of our

identification strategy, reallocated borrowers are excluded from the analyses due to the frictions

induced by loan officer turnovers discussed above.

Our first approach to implement this strategy utilizes the change in loan officer industry

specialization as continuous treatment variable. It enables us to identify the average impact of a

specialization shock on default rates across shock types. However, there are limitations attached

to this approach. First, averaging across shock types prevents us from disentangling the impact of

positive and negative specialization shocks on default rates and implicitly assumes symmetric

13
treatment effects for both types. Exploring both shock types separately might be important in our

setting because a shock to loan officer specialization does not imply a marginal, but a substantial

specialization change. In contrast to marginal specialization changes, negative and positive

specialization shocks therefore do not have to result in symmetric effects. Second, without forming

treatment and control groups we can neither check nor improve covariate balance between exposed

and unexposed borrowers.

Our second and main approach to pursue our identification strategy seeks to overcome these

limitations. It involves the explicit formation of treatment and control groups to compare the

difference in default rates before and after the reallocation period between borrowers who are

exposed to a shock to loan officer industry specialization and borrowers whose loan officer

specialization remains largely unaffected (difference-in-differences approach). We form treatment

and control groups as follows: Borrowers who experience a negative [positive] shock to industry

specialization (belong to the bottom [top] quartile7 in terms of specialization change) are assigned

to the treatment (-) [treatment (+)] group. Borrowers whose specialization levels exhibit only a

minor negative [positive] change due to the reallocation form the control (-) [control (+)] group.

This design allows us to hold the direction of the specialization change constant when comparing

treatment group borrowers to the respective control group and focuses on the varying degree to

which borrowers experienced a shock to loan officer specialization. Compared to the pre-

reallocation period, the loan officer’s precision of default-relevant information about the respective

industry has deteriorated [improved] for the treatment (-) [treatment (+)] group. This precision has

remained largely unchanged for the respective control group.

7
Using alternative thresholds (20%, 30%) leaves our main results qualitatively unchanged.

14
4. Data and methodology

4.1. Descriptive statistics

4.1.1. Data and variable overview

Our proprietary data set provides us with monthly information on the bank’s entire SME

borrower portfolio from January 2006 to December 2012 (8,188 SMEs; 465,158 firm-month

observations). In addition to detailed credit, borrower, and bank-borrower relationship

characteristics, it contains information on which loan officer is assigned to a borrower at a given

point in time. This allows us to construct borrower portfolios at the loan officer level and to

calculate an industry-specific measure of loan officer specialization.

Our identification strategy imposes the following requirements for SME borrowers to be

included in our analysis. Borrowers need to be in the sample before the reallocation period, never

switched loan officers, and must be monitored by a loan officer who does not retire during the

reallocation period. Moreover, as controlling for borrowers’ ex ante default risk is crucial in default

rate analyses, we only include borrowers who have an internal credit rating assigned by the bank.

As our identification strategy requires a comparison of default rate differences before and after the

reallocation period, all observations from the reallocation period are excluded from our analysis.

Adhering to these restrictions leaves us with 4,806 SMEs and 220,100 firm-month observations.

As we explore the impact of loan officer industry specialization on credit defaults, the

dependent variable in our analysis is whether a SME borrower defaults in a given month. During

the entire sample period, 175 SME borrowers of the bank default. A default event is identified by

considering the bank’s internal credit rating (ranging from one to nine, with one indicating the

lowest default risk). When a borrower defaults, its internal credit rating is downgraded (increased)

to the rating grade nine. Hence, the month in which the borrower’s rating is increased to nine

15
indicates the default event. All firm observations after its default are dropped. Because of this, cure

events do not play a role in our analyses.

We next discuss the construction of our main variables (see Table 1 for summary statistics).

Loan officer industry specialization measures a loan officer’s level of industry specialization and

is calculated as the product of a loan officer’s monitoring time and industry expertise to the power

of 0.5 (see Section 2 and Section 4.1.2 for details). We employ the bank’s internal credit rating to

measure a borrower’s ex ante default risk. Further borrower characteristics are given by the credit

line interest rate charged by the bank, the credit line debt, the credit line limit, the collateral value,

and the nominal loan amount outstanding. We transform the latter four variables by taking the

natural logarithm of (1 + variable value) (Cerqueiro et al., 2016). In 1/2006, the SME borrowers

in our sample have €24,892 in credit line debt and a nominal loan amount of €129,405 on average.

The mean credit line limit is €85,301, the collateral value averages €30,667.

(Insert Table 1 about here)

Our data set furthermore includes several bank-borrower relationship characteristics. We

measure the physical distance between the borrower’s location (which is, due to confidentiality

reasons, approximated by the bank branch nearest to the SME) and the headquarter where the loan

officer is located utilizing Google Maps©. Always considering the route with the shortest round

trip travel time by car yields a median driving time of 29 minutes for the loan officer to make an

on-site visit at the borrower’s location and return to the headquarter. The mean length of the bank-

borrower relationship (duration) is 20.377 years. We measure bank competition as the number of

branches from competing banks in a borrower’s ZIP Code, as well as for all surrounding ZIP Codes

(18.400 on average). Table 1 also provides the industry composition of our borrower sample. Most

common are retail (21.4%), other services (19.4%), and non-profit (15.5%), followed by

16
construction (12.2%), manufacturer (10.5%), housing (6.8%), and logistics (6.8%). Agriculture,

utilities, and finance/insurance are the least common industries with 5% or less each.

4.1.2. Loan officer specialization

We next provide an example to illustrate the construction of our loan officer industry

specialization measure, discuss its distributional properties at the loan officer level, and explore

how it correlates with important loan officer, industry, and borrower characteristics.

To illustrate the construction of our specialization measure, we consider a loan officer from our

sample who monitors 135 borrowers from all industries in the last month before the reallocation

period (6/2007). For simplicity, we will focus on two industries in the following – housing and

construction. The loan officer monitors eight borrowers in the housing industry, which implies a

monitoring time according to our framework of 5.9% (=8/135). Given that the maximum number

of housing borrowers monitored by any loan officer in the bank amounts to 29, the loan officer’s

expertise with respect to that industry is 27.6% (=8/29). Hence, the specialization level of the loan

officer in the housing industry is 12.8% (=5.9%0.5 ∙ 27.6%0.5 ). In the construction industry, the

loan officer monitors 20 borrowers, while the maximum number of construction borrowers

monitored by any loan officer is 33. This results in a monitoring time of 14.8% (=20/135), an

industry expertise of 60.6% (=20/33), and a specialization level of 29.9% (=14.8%0.5 ∙ 60.6%0.5 ).

The distribution of loan officer industry specialization at the loan officer level is shown in

Figure 2. Panel A shows the distribution of the within loan officer specialization mean, averaged

over all borrowers and the last month before the reallocation period. The average borrower is

monitored by a loan officer with a mean industry specialization of 35.8%. We furthermore observe

considerable variation in the loan officer specialization mean, ranging from 7.0% to 70.8%.

Panel B shows the standard deviation of the within loan officer industry specialization level. The

17
standard deviation amounts to 17.4% on average, indicating that industry specialization levels also

strongly vary within loan officers.

(Insert Figure 2 about here)

We next explore how the specialization level correlates with key pre-reallocation loan officer

and loan officer-industry characteristics in the last month before the reallocation period. Table 2

reports results from regressing the loan officer industry specialization level on the respective

characteristic.

(Insert Table 2 about here)

The results in Table 2 suggest that there are no meaningful correlations between a loan officer’s

industry specialization and characteristics at the loan officer level. The R² is close to zero across

regressions and only the positive coefficient for the number of monitored borrowers is significantly

different from zero. The correlation between loan officer specialization and the default rate in the

pre-reallocation period is also virtually zero (Column (3)). While this result might partly be due to

the low default rates in the pre-reallocation period, there are two further issues to consider for

understanding why a negative correlation between loan officer industry specialization levels and

default rates might not be detected in a cross-sectional analysis. First, specialization levels might

not have the same impact on default rates across industries because they could differ in their degree

of borrower heterogeneity, causing variation in monitoring difficulty and information recycling

potential across industries. Second, loan officers might not be able to utilize the same specialization

level equally effective. Some loan officers might be better in translating higher specialization

levels into superior information and ultimately lower default rates than others. Our identification

strategy overcomes these challenges as it relies on within loan officer-industry specialization

changes and not specialization levels.

18
 Among the loan officer-industry characteristics, only those stand out which have a mechanical

relationship with a loan officer’s industry specialization level. Industry expertise (Column (4)) and

monitoring time (portfolio share; Column (6)) are the two factors that are used to construct loan

officer industry specialization. Not surprisingly, the R² in both regressions is high, with industry

expertise having comparably more explanatory power (74.5% vs. 57.5%). As the number of

borrowers within an industry increases both factors, the significant coefficient and high R² (82.8%)

in Column (5) is as expected.

We furthermore analyze how the industry specialization levels correlate with the likelihood of

observing a rating change at the borrower level in the pre-reallocation period. Due to their more

precise default-relevant industry information, loan officers with higher specialization levels might

be able to assign more accurate ratings to borrowers in the screening process. This, in turn, should

reduce the need for later rating adjustments and hence the likelihood for observing rating changes.

In a probit regression, we indeed find that a rating change (down- or upgrade) in a given month is

less likely to occur for borrowers who are monitored by more specialized loan officers (p < 0.05;

regression results not shown). However, the average marginal effect is economically rather small

(-1.4% when increasing the industry specialization level by 100%) and the explanatory power of

the model is close to zero, again pointing to the challenges of such a cross-sectional analysis based

on the specialization level.

4.2. Empirical specifications

Our identification strategy requires a comparison of default rate differences before and after the

reallocation period between borrowers who vary in the degree to which they experienced a shock

to loan officer specialization. To ensure that the standard errors in the OLS regressions do not

19
suffer from serial correlation, we employ two-way clustered standard errors (clustering on the time

and loan officer-industry level; Petersen, 2009).

In our first specification, we employ the change in loan officer industry specialization as

continuous treatment variable to identify the average impact of a specialization

shock on default rates across shock types. 𝐿𝑜𝑎𝑛 𝑜𝑓𝑓𝑖𝑐𝑒𝑟 𝑠𝑝𝑒𝑐𝑖𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑐ℎ𝑎𝑛𝑔𝑒𝑖,𝑡 is zero for all

borrowers before the reallocation period and indicates the specialization change throughout the

reallocation period afterwards. Hence, an interaction with a pre-post reallocation period dummy

variable is not necessary in this setup. Instead, the treatment effect is captured directly by the

variable’s coefficient. In the regression models, 𝑖 indexes borrowers and 𝑡 indexes time periods:

𝐷𝑒𝑓𝑎𝑢𝑙𝑡𝑖,𝑡+1 = 𝛼 + 𝛽1 ⋅ 𝐿𝑜𝑎𝑛 𝑜𝑓𝑓𝑖𝑐𝑒𝑟 𝑠𝑝𝑒𝑐𝑖𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑐ℎ𝑎𝑛𝑔𝑒𝑖,𝑡 + 𝛾 ∗ 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑠𝑖,𝑡 + 𝜀𝑖,𝑡 . (5)

Our second and main specification identifies treatment effects based on group comparisons

within each shock type, implementing our difference-in-differences approach. It tests whether the

difference in default rate changes from before to after the reallocation period between treatment

and control group borrowers is significant. 𝑇𝑟𝑒𝑎𝑡𝑚𝑒𝑛𝑡𝑖 is a nominal variable indicating whether

a borrower belongs to the treatment (-) [treatment (+)] group or the control (-) [control (+)] group.

𝑃𝑜𝑠𝑡𝑡 indicates whether a given month belongs to the pre-reallocation period (equals zero) or the

post-reallocation period (equals one). The 𝑇𝑟𝑒𝑎𝑡𝑚𝑒𝑛𝑡𝑖 ∗ 𝑃𝑜𝑠𝑡𝑡 interaction term captures the

difference in default rate changes between the respective treatment and control groups

(difference-in-differences estimate).

𝐷𝑒𝑓𝑎𝑢𝑙𝑡𝑖,𝑡+1 = 𝛼 + 𝛽1 ⋅ 𝑇𝑟𝑒𝑎𝑡𝑚𝑒𝑛𝑡𝑖 ∗ 𝑃𝑜𝑠𝑡𝑡 + 𝛽2 ∙ 𝑇𝑟𝑒𝑎𝑡𝑚𝑒𝑛𝑡𝑖 + 𝛽3 ∙ 𝑃𝑜𝑠𝑡𝑡 + 𝛾 ∗ 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑠𝑖,𝑡 + 𝜀𝑖,𝑡 . (6)

20
 In both specifications, the dependent variable captures whether a borrower defaults (variable

equals one) or not (variable equals zero) in the next month (𝐷𝑒𝑓𝑎𝑢𝑙𝑡𝑖,𝑡+1 ).8 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑠𝑖,𝑡 resembles

a vector of the included covariates and fixed effects. As Montgomery et al. (2018) point out that

conditioning on posttreatment variables in experiments can bias estimates, the control variables

employed in our regressions are determined as pre-reallocation period means and are unrelated to

the treatment. We include the following controls due to their relevance in the credit default context:

Bank-borrower distance (Petersen and Rajan, 2002; Degryse and Ongena, 2005; Hauswald and

Marquez, 2006; DeYoung et al., 2008; Agarwal and Hauswald, 2010; Dierkes et al., 2013), length

of the bank-borrower relationship (duration) and firm age (Kysucky and Norden, 2016; Puri at al.,

2017; Hibbeln et al., 2020), bank competition (Marquez, 2002; Degryse and Ongena, 2005; Scott

and Dunkelberg, 2010), and the pre-reallocation average internal credit rating. We also control

for the pre-reallocation specialization level quartile a loan officer belongs (Q1 to Q4) to account

for general differences in monitoring effectiveness across quartiles (Boot and Thakor, 2000) and

potentially adverse effects of favoritism that loan officers with high industry specialization might

be exposed to (Haselmann et al., 2018). To check the robustness of our results, we estimate

regressions both with and without these controls.

In addition, we saturate our regressions with a rich set of fixed effects. To rule out that

unobserved loan officer characteristics as well as the change in loan officer workload drive our

results, we include loan officer-by-time fixed effects. This absorbs any common time varying

8
We employ OLS regressions and therefore the linear probability model in our setting because even though our
dependent variable is binary (default yes/no), the key element in our difference-in-differences analyses is to compare
mean (default rate) changes across treatment and control groups. Hence, we are interested in the differences regarding
average effects between groups and over time, rendering OLS regressions appropriate in our context. Non-linear
probability models (logit/probit) would only add unnecessary complexity to our analyses (for a discussion, see
Mood, 2010).

21
differences within an individual loan officer’s portfolio and enables a within loan officer

comparison of treatment and control group borrowers. Based on a similar argument, we include

industry-by-time, region-by-time, and size-by-time fixed effects.9 Including these fixed effects

ensures that a comparison is made between borrowers of the same size who operate in the same

industry and region. We thereby rule out that the estimated differences in default rate changes are

due to industry, region, or firm size-specific differences between treatment and control groups.10

Saturating our regressions with these fixed effects also helps reducing potential selection

concerns as the following fictitious example illustrates. Suppose the bank would have reallocated

borrowers so that loan officers who recently showed a more promising trend with respect to some

performance metric – that is unobserved to us – exhibited more favorable industry specialization

changes (positive or at least zero). In contrast, borrower reallocations would have caused

underperforming loan officers to exhibit largely negative or at most zero specialization changes.

Now further assume that (i) both types of loan officers had a default rate of zero before the

reallocations, (ii) default rates more strongly increased for under- than for outperforming loan

officers after the reallocation, and (iii) post-reallocation default rates are randomly distributed

across industries at the loan officer level. Without including loan officer-by-time fixed effects, the

difference-in-differences estimate would likely be negative and significant, suggesting a

9
Size-by-time fixed effects absorb time varying, firm size-related differences. Size is measured by the bank and
classifies a firm either as small, medium, or large. As the bank does not only consider a firm’s turnover but also other
attributes such as its legal form and number of employees when assigning a firm to a size category, it is only a rough
approximation of the characteristics that are typically associated with firm size (such as total assets or sales). Because
it is the only information about a firm’s size in our data set, we nevertheless utilize it in the analyses. Our results also
hold without including size-by-time fixed effects.
10
In unreported robustness tests, we estimated our main regressions, first, without any fixed effects and, second, by
sequentially including them. The obtained results are qualitatively unchanged.

22
systematic relationship between industry specialization changes and credit defaults. This result

would be incorrect though because default rates have been assumed to be randomly distributed

across industries in this example and are therefore independent of the specialization change. This

spurious regression result is caused by the difference-in-differences estimate picking up the

variation in credit defaults that is caused by loan officer differences regarding the unobserved

performance metric. By including loan officer-by-time fixed effects, the between loan officer

variation in credit defaults is fully absorbed and only the within loan officer variation in default

rates between industries with different industry specialization changes is used for identification. A

regression including these fixed effects would therefore correctly yield a difference-in-differences

estimate that is close to zero and insignificant, as default rates have been assumed to be randomly

distributed across industries in this example. Hence, including fixed effects in our regressions

effectively mitigates potential selection concerns, in addition to the analyses conducted in the

following section.

4.3. Randomness of the borrower reallocations

As the change in loan officer industry specialization plays a central role in our empirical

specifications, we next discuss its distribution at the loan officer level. To address potential

selection concerns, we then evaluate whether the reallocation-induced specialization changes (and

hence the assignment to treatment and control groups) can be considered random.

Figure 3 shows the distributional properties of the within loan officer industry specialization

change that occurred during the borrower reallocation period. Panel A shows the distribution of

the within loan officer specialization change mean, averaged over all borrowers in the last month

before the reallocation period (6/2007). Analogous, Panel B shows the standard deviation of the

within loan officer industry specialization change. The within loan officer specialization change

23
mean ranges from -34.0% to 64.7% and is quite symmetrical distributed around its average

of -0.2%. Moreover, the change in industry specialization varies considerably within loan officer,

with the standard deviation amounting to 8.6% on average.

(Insert Figure 3 about here)

To scrutinize the randomness of the borrower reallocations, we next explore how key pre-

reallocation loan officer and loan officer-industry characteristics predict the change in loan officer

industry specialization. If reallocations are indeed largely random, such characteristics should not

be able to systematically predict the specialization change. Table 3 reports results from regressing

the continuous treatment variable loan officer specialization change on the respective

characteristic.

(Insert Table 3 about here)

The results in Table 3 suggest that there are no systematic selection issues present that could

undermine the validity of our results. The R² is close to zero across regressions, indicating that

none of the characteristics have meaningful explanatory power with respect to the observed

specialization change. Furthermore, we do not find a systematic relationship between most (13) of

the 16 characteristics and the change in industry specialization.

Reallocations were not used to improve or at least maintain the industry specialization of loan

officers with higher pre-reallocation specialization levels (no selection on specialization). The

corresponding coefficient is negative (p < 0.05; Column (4)), implying that loan officers with

higher specialization levels tend to, in fact, suffer from worse specialization changes than those

with lower levels.

The regression results also speak against a selection on ability. If the bank identifies loan

officers with better average credit ratings in an industry as the better screeners/enforcers with

24
respect to that industry, the bank might have tried to further increase the specialization levels of

such loan officers in those industries. Given that a higher rating indicates higher credit risk, this

argument predicts a negative and significant correlation between the change in loan officer

specialization and the average rating of the industry-specific borrower portfolio that a loan officer

monitors before the reallocation period. However, the corresponding coefficient in Column (7) is

not significantly different from zero.

In addition to these regression analyses, we conduct two more tests to further explore the

randomness of the borrower reallocations. First, we conduct a simulation to scrutinize whether the

observed borrower reallocation can be distinguished from a truly random reallocation. The results

reported in Internet Appendix A suggest that the observed reallocation is in line with reallocations

that are the result of a random process. This is supporting evidence for the observed borrower

reallocation being as-if random. Second, we conduct our default rate regressions based on the

continuous treatment variable both with and without including controls or fixed effects. In a truly

random experiment, the results should not depend on their inclusion. The results in Table 5 indicate

that this also holds true for our setting, lending further support to the randomness of the borrower

reallocations.

4.4. Covariate balance, matching, and pre-treatment trends

Aside from the randomness of the borrower reallocations, we need to scrutinize the covariate

balance of the formed treatment and control groups. Table B.1 in Internet Appendix B provides

pre-reallocation period means by treatment and control groups and results from

difference-of-means tests. For both shock types, we observe several significant differences

between treatment and control groups. Hence, improving the covariate balance across groups

seems warranted to rule out these differences as drivers of our results.

25
 To improve covariate balance, we conduct propensity score matching (PSM) and employ

matched samples whenever conducting group-based analyses. We employ PSM using the

Epanechnikov kernel and a bandwidth of 0.01 to balance pre-reallocation period means between

treatment and control groups. In addition to all controls that are considered in the regressions and

unrelated to the treatment (internal credit rating, duration, distance, firm age, competition), we

match on further default relevant characteristics including the credit line interest rate, nominal

loan amount (Norden and Weber, 2010), credit line limit, credit line debt, and collateral value

(Bester, 1985; Chan and Thakor, 1987; Rajan and Winton, 1995; Baele et al., 2014). Moreover,

we match on borrower industry to reach a comparable industry composition across groups.

Table 4 displays summary statistics for the matching variables by treatment and control groups

based on the matched samples. As it is necessary to optimize the covariate balance for the two

treatment groups separately, it reports summary statistics for the control (-) group, consisting of

the matched borrowers for the treatment (-) group, and the control (+) group, consisting of the

matched borrowers for the treatment (+) group. Table 4 also provides difference-of-means tests.

(Insert Table 4 about here)

Only one of the mean differences remains statistically significant, pointing to a successful

application of PSM. The share of borrowers in the utility industry is higher in the treatment (-)

than in the control (-) group. The difference is not economically meaningful though (1.3%) and

will be accounted for by including industry-by-time fixed effects in the regressions.

Figure 4 further underlines the suitability and effectiveness of the applied PSM algorithm by

comparing the density distributions of propensity scores before and after matching across groups.

The comparisons indicate that PSM substantially improved the comparability of propensity score

26
distributions between the respective treatment and control group borrowers as their post-matching

density curves coincide.

(Insert Figure 4 about here)

To check whether treatment and control groups have similar pre-treatment trends in default

rates we run placebo regressions, using only pre-reallocation data and the midpoint of this time

period as the placebo event date. In the placebo regressions, the difference-in-differences estimates

are not significant, providing supporting evidence for parallel pre-treatment trends across groups.

Panel A of Figure 5 shows that treatment and control groups are comprised of borrowers who

cover the full range of the specialization spectrum. Borrowers from both treatment groups are quite

evenly distributed across pre-reallocation specialization levels, control group borrowers are more

frequently monitored by loan officers with low or intermediate specialization levels.11 Panel B

shows that the average change in the number of borrowers per loan officer is very similar across

groups, ruling out differences in loan officer workload as driver of our results. Panel C shows that

a negative [positive] specialization shock implies a substantial decrease [increase] in industry

specialization of about -14.9% [+16.5%] on average. The same figure amounts -3.3% [+2.8%] for

borrowers in the control (-) [control (+)] group. Panel D confirms this pattern for each

specialization quartile.

(Insert Figure 5 about here)

11
We account for a potential impact of these differences by including the pre-reallocation industry specialization level
quartile in the set of control variables when estimating the respective regressions. Moreover, as these differences are
similar for both shock types, they cannot explain opposite treatment effects across shock types.

27
5. Results

5.1. Shocks to loan officer specialization and credit defaults

We first provide an intuitive graphical analysis on the default rate development based on group

comparisons. Panels A and B of Figure 6 plot credit default rates for treatment and control groups

over the entire sample period, providing insight on the dynamics of the observed treatment effects.

The pre-reallocation period levels of the six-month moving average default rate are similarly low

for all groups, but the post-reallocation levels are considerably different.

(Insert Figure 6 about here)

Panel A shows the default rate development for borrowers in the treatment (-) and control (-)

groups. Default rates generally rise during the global financial crisis and decline afterwards.

However, borrowers in the treatment (-) group exhibit higher default rates at almost all points in

time than borrowers in the control group. The largest differences in default rates range between

approximately 5 and 20 basis points and occur shortly after the reallocation period (0.15% vs.

0.05%), in the aftermath of the financial crisis (0.40% vs. 0.20%), and at the end of our sample

period (0.05% vs. 0.00%). Default rate differences narrow between the years 2010 and 2012. This

is consistent with the improved economic conditions during that time span and the fact that

monitoring related disadvantages (such as credit defaults) are most likely to materialize during

economic downturns (Winton, 1999).

Panel B displays the default rate development for borrowers in the treatment (+) and control (+)

groups. Borrowers in the treatment (+) group exhibit lower default rates than control (+) group

borrowers at almost all points in time. The largest absolute differences range between

approximately 5 and 15 basis points, occurring in the aftermath of the financial crisis (0.17% vs.

0.32%) and at the end of our sample period (0.00% vs. 0.05%).

28
 The developments in Figure 6 imply a difference in pre-post default rate differences between

treatment (-) and control (-) groups of approximately +10 basis points (difference-in-differences).

The same figure amounts to about -5 basis points when comparing the treatment (+) to the

control (+) group. These findings suggest that a negative [positive] shock to loan officer industry

specialization has an adverse [beneficial] impact on credit default rates of SMEs. Next, we will

scrutinize the robustness of these results using regression analysis.

We employ two regression specifications to analyze the impact of a shock to loan officer

specialization on credit default rates. First, we explore the impact of a change in loan officer

industry specialization based on the continuous treatment variable. This specification allows us to

identify the average impact of a specialization shock across shock types. Second, we run

regressions employing the respective treatment and control groups based on the matched samples.

We thereby can explore treatment effects within groups that are exposed to the same direction in

terms of specialization change and are of high covariate balance.

Table 5 provides results for our first specification. In all four regressions, the dependent variable

captures whether a borrower defaults or not in the next month (Defaultt+1). The first regression

only includes the continuous treatment variable (loan officer specialization change) as regressor.

The second regression additionally includes our set of control variables (internal credit rating,

duration, distance, firm age, competition, loan officer pre-reallocation specialization quartile).

The third regression includes the treatment variable and considers loan officer-by-time,

industry-by-time, region-by-time, and size-by-time fixed effects. The fourth regression is identical

to the third but additionally includes the set of control variables. Reported coefficients are scaled

and should be interpreted as basis points. A marginal change in the continuous treatment variable

29
from zero to one implies an increase in loan officer industry specialization of 100% and therefore

corresponds to a shock.

(Insert Table 5 about here)

The results in Table 5 are highly similar across regressions, emphasizing their independence of

including controls or fixed effects and lending further support to our experimental design being

as-if random. The coefficient of the continuous treatment variable is always negative and highly

significant (p < 0.01), indicating that a shock to loan officer industry specialization affects credit

default rates of SME borrowers on average.12 Borrowers who exhibit a negative shock to loan

officer specialization during the reallocation period are more likely to default. Likewise, a positive

specialization shock decreases default risk.13

The economic interpretation of the treatment variables’ coefficients in Table 5 is as follows:

For example, the negative coefficient of -17.978 in Column (1) indicates that the default rate

difference from before to after the reallocation decreases by about 18 basis points when the change

in loan officer industry specialization increases by 100%. Such an increase approximates, e.g., the

difference between borrowers exposed to the most positive specialization changes and those with

the most negative changes in our sample. Hence, borrowers with the most favorable specialization

changes have an estimated pre-post-reallocation difference in average monthly default rates that is

about 18 basis points lower compared to borrowers with the worst changes in loan officer industry

specialization.

12
Using a probit model instead of the employed linear probability model leaves our results qualitatively unchanged.
13
These results suggest that it should also be possible to detect the negative relationship between the change in loan
officer industry specialization and default rates in a cross-sectional, correlation-based analysis. Indeed, the resulting
correlation is negative (ρ = -0.098) and significant (p < 0.05).

30
 Table 6 provides regression results for our second specification. As before, the dependent

variable captures whether or not a borrower defaults in the next month (Defaultt+1). However, the

set of independent variables now comprises the dummy variables identifying the respective

treatment group (Treatment (-), Treatment (+)), their interaction with the pre-post reallocation

period dummy variable (Post), and the set of control variables. The presented

difference-in-differences estimates (Treatment * Post) capture the difference in the pre-post-

reallocation change in average monthly default rates between the respective treatment and control

groups. The Post dummy itself is absorbed by the time-varying fixed effects. Moreover, all four

reported regressions include the full set of time-varying fixed effects but differ with respect to the

included control variables (none/all). A combined estimation for treatment (-) and treatment (+)

groups is not possible when employing matched samples because the respective (matched) control

groups are distinct. Hence, regressions 1 and 2 yield the results for the treatment (-) group and

regressions 3 and 4 for the treatment (+) group.

(Insert Table 6 about here)

The results in Table 6 confirm our previous conclusions. In case of a negative specialization

shock, the difference-in-differences estimates for the treatment (-) group are positive and

significant across specifications (p < 0.01). Negatively shocked borrowers exhibit a pre-post-

reallocation increase in average monthly default rates that is about 11 basis points higher compared

to the control (-) group. Regarding a positive industry specialization shock, we observe negative

and significant difference-in-differences estimates (p < 0.05). Borrowers in the treatment (+)

31
group benefit from an about 8 basis points lower increase in default rates compared to the

control (+) group.14

In the robustness tests reported in Internet Appendix C, we repeat the analyses for both

regression specifications using collapsed samples. To do so, we collapse our data to one pre- and

post-reallocation observation per firm (Bertrand et al., 2004) instead of employing the full panel

data set and two-way clustered standard errors (Petersen, 2009). This alternative approach to

account for potential serial correlation leaves our results qualitatively unchanged.

To sum up, our results indicate that default rates of SME borrowers are significantly affected

by a shock to loan officer industry specialization. Borrowers exposed to a negative shock exhibit

higher default rates compared to their control group. A positive shock is associated with a lower

increase. These findings point to the general importance of loan officer industry specialization in

the credit default context.

5.2. Channels

5.2.1. Information channel

Our main result from the previous section is that default rates of SME borrowers are

significantly affected by a shock to loan officer industry specialization. A negative shock increases

default rates compared to control group borrowers. A positive shock relatively decreases default

14
In an unreported robustness test, we explored whether the impact of a specialization shock on credit default rates
might take longer to fully materialize. We therefore reran all regressions for both specifications but varied the time
horizon of the dependent variable. Instead of capturing whether a borrower defaults or not in the next month, it
alternatively captures whether a borrower defaults in three, six, or twelve months. We find that the difference-in-
differences estimate tends to slightly increase (in absolute terms) for longer time horizons, providing supporting
evidence that the impact of a specialization shock fully materializes only with some delay. As might be expected, this
tendency is more pronounced for a positive than for a negative specialization shock. Detailed results available on
request.

32
rates. These findings raise the question as to whether differences in monitoring effectiveness, i.e.,

an inferior or superior information production about the borrowers’ default risk, can explain our

results. If, indeed, the negative [positive] specialization shock compromised [improved] loan

officers’ ability to produce industry-specific information and to exploit related synergies, newly

acquired default risk information should be less [more] valuable for predicting defaults of

borrowers in the treatment (-) [treatment (+)] group than of those in the respective control group.

To test the validity of the proposed information channel, we compare the informational value

of internal credit rating changes for predicting post-reallocation borrower defaults across groups.

The internal credit rating captures the bank’s aggregate default risk information about its borrowers

and crucially hinges on the information provided by the loan officer in charge. The rating is based

on two components. First, it considers hard information such as a borrower’s financial statements.

Second, it incorporates soft information about, e.g., the borrower’s management quality and firm

strategy (on the role of non-financial factors in internal credit ratings at German banks, see

Grunert et al., 2005). The latter is produced and assessed by the monitoring loan officer and is an

important determinant of the borrower’s internal credit rating and rating changes. Since all loan

officers within the bank use the same algorithm to evaluate hard information and borrower

characteristics are balanced across groups due to PSM (holding the level of borrower opaqueness,

default risk, and thus default prediction difficulty constant across groups), differences in the

informational value of rating changes indicate differences in the quality of soft information

produced by loan officers. As most loan officers monitor borrowers from both the treatment and

33
respective control groups, the loan officer distribution is rather stable across groups, allowing us

to rule out that unobserved loan officer characteristics drive our results.15

A positive rating change (rating upgrade) should be indicative of a default becoming less likely.

A negative rating change (rating downgrade) should be associated with an increase in a borrower’s

probability to default. If a negative [positive] shock to loan officer industry specialization led to

an inferior [superior] production of default risk information, changes made to the internal credit

rating by the responsible loan officer should improve default predictions less [more] for the

treatment (-) [treatment (+)] than for the respective control group.16

We therefore run probit regressions predicting post-reallocation borrower defaults for each

group and a time horizon of twelve months, using the cumulated number of rating downgrades

and rating upgrades since the reallocation period at the borrower level as the only two independent

variables. If the rating changes based on the newly acquired information are valuable for predicting

defaults, the explanatory power of the probit model considering these rating changes should

increase relative to the constant-only model. This percentage increase in explanatory power is

captured by the respective McFadden R² and can be interpreted as the estimated information gain

generated by rating changes in comparison with the constant-only model (Shtatland et al., 2002).

If loan officers produce inferior [superior] default risk information when making rating changes,

15
In an unreported robustness test, we adjust our PSM algorithm to balance the loan officer distribution across
treatment and control groups. To do so, we are forced to eliminate borrower industry from the set of matching variables
because an industry either belongs to the treatment or the control group at the loan officer level. Employing this
alternative specification leaves our results qualitatively unchanged.
16
In an unreported robustness test, we explore how the change in loan officer specialization correlates with the
likelihood to observe a rating change (down- or upgrade) in a given month since the reallocation period. We do not
find a significant impact of the loan officer industry specialization change on the probability to observe a rating change,
suggesting that differences in rating activity across groups cannot explain our results.

34
the estimated information gain and hence informational value is expected to be lower [higher].

Comparing the McFadden R² across treatment and control groups therefore allows us to infer

differences in the informational value of rating changes for predicting post-reallocation defaults.

Table 7 provides the corresponding regression results based on the matched samples.

(Insert Table 7 about here)

The results in Table 7 indicate that rating downgrades typically increase a borrower’s propensity

to default, while rating upgrades are indicative of a lower default risk. These results are in line

with expectations and are not of special interest to us here. Instead, we are concerned about

differences in the informational value of rating changes across treatment and control groups.

The additional value of rating changes for predicting post-reallocation borrower defaults is

substantially smaller for the treatment (-) group than for the control (-) group. The respective

McFadden R² in Column (1) is 27.4% lower compared to the McFadden R² for the control (-) group

in Column (2). These results indicate that the newly acquired default risk information encoded in

the rating changes is less valuable for borrowers in the treatment (-) group than for those in the

control (-) group. Thus, the more pronounced pre-post-reallocation increase in default rates for

treatment (-) group borrowers can be explained by an inferior default risk information production

by the responsible loan officers.

The results for the treatment (+) group are also in line with the corresponding default rate

development. The McFadden R² is 40.9% higher for treatment (+) group than for control (+) group

borrowers (columns (3) and (4)). Hence, the less pronounced pre-post-reallocation increase in

35
default rates for these borrowers can be explained by their loan officers’ superior default risk

information production.17

As inferior or superior information about the borrowers’ default risk does not in and of itself

produce credit defaults, we explore the corresponding lending decisions, which ultimately might

cause borrowers to default, in the next section.

5.2.2. Lending channel

The most obvious channel on how a change in loan officer industry specialization and the

associated inferior or superior information production about the borrowers’ default risk could

affect default rates is the granted loan volume. On the one hand, a drop in loan officer specialization

and a less accurate default risk evaluation might induce loan officers to mistakenly lend the wrong

amount to some borrowers, ultimately causing them to default. On the other hand, an increase in

loan officer specialization and more accurate default risk information might trigger improved

lending decisions, contributing to a reduction in borrower default risk.

We therefore analyze the development of granted loan volumes for borrowers in the treatment

and control groups. To do so, we employ the same regression specification underlying Table 6 but

employ the nominal loan amount as dependent variable instead. Hence, the difference-in-

differences estimates presented in Table 8 inform about how much the nominal loan amount has

changed more or less strongly compared to the respective control group based on the matched

samples. As the nominal loan amount is measured in logs, the difference-in-differences estimates

can be interpreted as percentage changes.

17
Results in Internet Appendix D provide further evidence that these differences in informational value are most likely
driven by industry-specific rather than borrower-specific information.

36
 (Insert Table 8 about here)

The difference-in-differences estimates for the treatment (-) group in Table 8 indicate a

considerably stronger loan growth for this group compared to the control (-) group. Their nominal

loan amount increases 42.5% more strongly (p < 0.10; Column (2)). This result suggests that the

inferior production of default risk information by the loan officers in charge caused excessive

lending which triggered the rise in future credit defaults. The fact that abnormal loan growth has a

negative impact on loan performance is in line with previous studies (Foos et al., 2010). In addition,

the analysis in Internet Appendix E rules out evergreening as potential explanation for the stronger

increase in loan growth of nonperforming borrowers. Treatment (-) group borrowers therefore

received loan amounts that they should not have gotten in the first place and which they probably

would not have gotten in presence of more accurate default risk information.

This loan growth pattern is reversed for borrowers who experience a positive shock to loan

officer specialization. Borrowers in the treatment (+) group exhibit less loan growth than

control (+) group borrowers (-54.9%, p < 0.05; Column (4)). These findings indicate that a

superior information production of default risk information caused by the positive specialization

shock for borrowers in this group induced loan officers to be more conservative in expanding

borrowers’ loan volumes, which got rewarded with a better default rate development.

Without considering the price of credit or the bank’s collateral demands, it might be premature

to classify stronger [weaker] loan growth on its own as a sign for excessive [conservative] lending.

If, for instance, loan officers were aware of the higher risk involved with the stronger credit

expansion in the treatment (-) group, they would have demanded higher loan rates or more

collateral. We therefore additionally explore the development of these credit characteristics. In

37
unreported regressions, we do not find any significant differences with respect to loan rate or

collateral changes between treatment and control groups.

Hence, even though treatment (-) group borrowers are granted stronger loan growth, their loan

rates and collateral values are not increased more strongly compared to the control (-) group. This

lending behavior can be described as excessive. In contrast, treatment (+) group borrowers exhibit

less growth in loan volumes but face a similar development in loan rates and collateral values as

control (+) group borrowers, pointing to a rather conservative lending behavior of the respective

loan officers.

A negative shock to loan officer industry specialization therefore implies an inferior production

of default risk information which results in excessive lending and ultimately higher credit default

rates for borrowers in the treatment (-) group. In contrast, a positive specialization shock facilitates

a superior production of default risk information, leading to more conservative lending decisions

and lower default rates for borrowers in the treatment (+) group.

6. Conclusion

Loan officer specialization has been proposed as being an important determinant of borrower

default rates on a theoretical level, but a comprehensive empirical examination of this issue has

been missing due to the typical lack of loan officer-level data and the involved identification

challenges. By utilizing a bank-provided proprietary data set and by exploiting a quasi-natural

experiment, we can contribute such an analysis. This paper provides empirical evidence for the

beneficial impact of loan officer industry specialization on the credit default rates of SMEs.

Key to our identification strategy is a wave of early loan officer retirements that occurred at the

bank during our sample period. It caused the need for reallocating borrowers from the retiring loan

officers to the remaining loan officers. These downsizing-induced, as-if random borrower

38
reallocations changed the industry specialization levels of the remaining loan officers. After

excluding all reallocated borrowers, we employ a difference-in-differences approach to compare

default rates of borrowers who experience a shock to loan officer specialization to those of

borrowers whose loan officers maintain their specialization levels.

We find that the pre-post-reallocation change in default rates is significantly affected by a shock

to loan officer specialization. Borrowers who are monitored by loan officers whose industry

specialization levels have been compromised during the reallocation period exhibit a stronger

increase in default rates than unexposed borrowers. A positive specialization shock leads to a

comparatively lower increase in default rates.

We identify differences in the information production about the borrowers’ default risk and

resulting variations in lending behavior as channels that explain our findings. A negative shock to

industry specialization triggers an inferior production of default risk information, inducing

excessive loan growth and ultimately higher credit default rates. A positive specialization shock

lowers default rates due to a superior production of default risk information and more conservative

loan growth.

Recent studies suggest that the beneficial impact of industry specialization on loan performance

at the loan officer level also translates to the bank level. In line with the identified monitoring

synergies-default rate mechanism, more specialized banks exhibit lower loan loss rates and

nonperforming loans, less unexpected credit risk, and fewer firm bankruptcies (Jahn et al., 2016;

De Jonghe et al., 2020; Beck et al., 2022). The increase in monitoring effectiveness is even found

to carry over from corporate lending to other lending activities within the bank (Chu et al., 2023).

In addition, the industry specialization-related default risk benefits seem not to hurt but rather help

bank profitability as loan portfolio concentration is found to improve bank returns (Tabak et al.,

39
2011). These positive effects of industry specialization on a bank’s risk and return profile

contributed to the substantial growth in industry-specialized lenders observed over the last two

decades (Di and Pattison, 2023; Blickle et al., 2023; Giometti and Pietrosanti, 2023).

Our study exploits downsizing-induced borrower reallocations to explore variations in industry

specialization at the typically unobserved loan officer level. As the borrower reallocations took

place shortly before the global financial crisis, one might argue that our results are (at least in terms

of their magnitude) somewhat tied to economic downturns that match the severity of the financial

crisis. While we do not disagree with this perspective, we consider this timing a strength rather

than a limitation for exploring the impact of industry specialization. Monitoring effectiveness is

most consequential with respect to affecting credit defaults during economic downturns (Winton,

1999). If the reallocations would have taken place just before a long period of high economic

stability and generally close to zero default rates, we likely would not have been able to detect the

merits of industry specialization in the credit default context and explore the underlying channels.

Moreover, during the last two decades alone at least two further economic downturns of similar

magnitude occurred (burst of the dot-com bubble in the early 2000s; the crash during the COVID

pandemic 2020 onwards), suggesting that the economic conditions underlying our study are more

common than one might think.

Two main implications can be derived from our results: First, it is attractive for banks to strive

toward and maintain a sustainable level of industry specialization among their loan officers as it

contributes to lowering credit default rates. Second, when banks consider cost-saving measures

that involve loan officer layoffs, they should be particularly aware of the related negative

externalities induced by reductions in loan officer specialization and the resulting future rise in

default rates.

40
Acknowledgments
We thank Thorsten Beck (the editor) and two anonymous reviewers for their constructive
comments and suggestions. We further thank Edward Altman, Tobias Berg, Diana Bonfim,
Martin Brown, Anne Duquerroy, Oliver Entrop, Emilia Garcia-Appendini, Jean Helwege, Björn
Imbierowicz, Michael Koetter, Martien Lamers, Thomas Langer, Maria-Teresa Marchica, Lars
Norden, Andreas Pfingsten, Mark Wahrenburg, and Laurent Weill for their valuable comments.
We are also grateful to participants at the 2018 Annual Meeting of the German Finance
Association (DGF) in Trier, the 2018 Banking Workshop Münster, the 2019 Annual Meeting of
the Swiss Society for Financial Market Research (SGF) in Zurich, the 2019 Annual Meeting of
the German Academic Association for Business Research (VHB) in Rostock, the 2019
International Risk Management Conference (IRMC) in Milan, the 2019 Annual Conference of
the Northern Finance Association (NFA) in Vancouver, the 2020 Annual Meeting of the Allied
Social Science Associations (ASSA) in San Diego, and the 2020 Banque de France Seminar on
Structural Issues in France for thoughtful discussions and comments.

CRediT author statement

Author 1:
Conceptualization; Data curation; Formal analysis; Investigation; Methodology; Project administra-
tion; Resources; Software; Supervision; Validation; Visualization; Writing – original draft; Writing –
review & editing.

Author 2:
Data curation; Investigation; Software.

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 Figures

Figure 1. Number of loan officers and monitored borrowers.

This figure shows the bank’s number of employed loan officers (Panel A) and the average number of monitored
borrowers per loan officer (Panel B) over the entire sample period (1/2006-12/2012). The dotted vertical lines indicate
the last month before (6/2007) and the first month after (8/2008) the reallocation period (7/2007-7/2008), respectively.

49
Figure 2. Distribution of the within loan officer specialization level.
This figure shows distributional properties of the within loan officer industry specialization level in the pre-
reallocation period. Panel A shows the distribution of the within loan officer specialization mean, averaged over all
borrowers and the last month before the reallocation period (6/2007). Panel B shows the standard deviation of the
within loan officer industry specialization level, averaged over all borrowers and the last month before the reallocation
period (6/2007). The dash-dotted vertical lines indicate the mean of the respective distribution.

50
Figure 3. Distribution of the within loan officer specialization change.
This figure shows distributional properties of the within loan officer industry specialization change that occurred
during the borrower reallocation period (7/2007-7/2008). Panel A shows the distribution of the within loan officer
specialization change mean, averaged over all borrowers in last month before the reallocation period (6/2007). Panel B
shows the standard deviation of the within loan officer industry specialization change, averaged over all borrowers in
the last month before the reallocation period (6/2007). The dash-dotted vertical lines indicate the mean of the
respective distribution.

51
Figure 4. Density distributions of the propensity scores before and after matching.
This figure shows the density distributions of the propensity scores for treatment and control groups before and after
matching. Propensity score matching using the Epanechnikov kernel is employed. Panel A [Panel B] depicts the
density distributions for the treatment (-) [treatment (+)] group. The treatment (-) [treatment (+)] group contains
borrowers who experience a negative [positive] shock to loan officer industry specialization throughout the borrower
reallocation period (7/2007-7/2008). Borrowers whose specialization levels exhibit only a minor negative [positive]
change due to the reallocation form the control (-) [control (+)] group.

52
Figure 5. Loan officer specialization, monitored borrowers, and specialization shocks.
This figure shows the distribution of pre-reallocation loan officer specialization, changes in monitored borrowers, and
the intensity of the specialization shock for treatment and control groups based on the matched samples. Panel A
shows the distribution of loan officer industry specialization in the last month before the reallocation period (6/2007).
The dash-dotted vertical lines indicate the upper bound of the respective loan officer specialization quartile. Panel B
shows changes in the average number of monitored borrowers per loan officer. Panel C shows average changes in
loan officer industry specialization over time. Changes are relative to the respective number in the last month before
the reallocation period. The dotted vertical lines in panels B and C indicate the last month before and the first month
after the reallocation period, respectively. Panel D shows average changes in loan officer industry specialization
throughout the reallocation period by pre-reallocation loan officer specialization quartile (Q1 to Q4). For the
treatment (-) [treatment (+)] group, it furthermore indicates the maximal [minimal] specialization change within each
quartile as well as the average change across quartiles. The treatment (-) [treatment (+)] group contains borrowers who
experience a negative [positive] shock to loan officer industry specialization throughout the borrower reallocation
period (7/2007-7/2008). Borrowers whose specialization levels exhibit only a minor negative [positive] change due to
the reallocation form the control (-) [control (+)] group.

53
Figure 6. Shocks to loan officer specialization and credit default rates.
This figure shows the six-month moving average default rates over time for treatment and control groups in case of a
negative [positive] shock to loan officer specialization based on the matched samples. Panel A [Panel B] depicts
default rates for the treatment (-) [treatment (+)] and control (-) [control (+)] groups. The treatment (-) [treatment (+)]
group contains borrowers who experience a negative [positive] shock to loan officer industry specialization throughout
the borrower reallocation period (7/2007-7/2008). Borrowers whose specialization levels exhibit only a minor negative
[positive] change due to the reallocation form the control (-) [control (+)] group. The dotted vertical lines indicate the
last month before and the first month after the reallocation period.

54
 Tables

Table 1. Summary statistics

This table displays summary statistics for our main variables. The sample period is 1/2006-12/2012.

Standard
Mean Median Deviation Observations
N (number of borrowers in group) 4,806
Loan officer industry specialization 0.373 0.332 0.247 220,100
Internal credit rating 3.790 3.500 2.090 220,100
Credit line interest rate 11.328 11.500 1.874 220,100
Credit line limit 8.894 10.127 3.653 220,100
Collateral value 3.307 0.000 4.838 220,100
Credit line debt 4.407 0.000 4.878 220,100
Nominal loan amount 5.043 0.000 6.020 220,100
Firm age 35.474 40.296 24.096 220,100
Distance: Round trip travel time (in minutes) 35.520 29.000 20.840 220,100
Duration: Relationship length with bank (in years) 20.377 18.749 12.493 220,100
Competition: Competing branches 18.400 18.000 6.062 220,100
Industry: Agriculture 0.050 0.000 0.219 220,100
Industry: Utilities 0.008 0.000 0.090 220,100
Industry: Manufacturer 0.105 0.000 0.307 220,100
Industry: Construction 0.122 0.000 0.327 220,100
Industry: Retail 0.214 0.000 0.410 220,100
Industry: Logistics 0.068 0.000 0.252 220,100
Industry: Finance/Insurance 0.015 0.000 0.123 220,100
Industry: Housing 0.068 0.000 0.251 220,100
Industry: Other services 0.194 0.000 0.396 220,100
Industry: Non-profit 0.155 0.000 0.361 220,100

55
Table 2. Explaining loan officer industry specialization
This table displays results from OLS regressions explaining variations in loan officer industry specialization in the last month before the borrower reallocation
period (6/2007). Explanatory variables represent key loan officer (LO) or loan officer-industry (LO-I) characteristics. Characteristics are measured in the month
before the reallocation period if not stated otherwise. Loan officer-industry characteristics based on borrower-level information are calculated as loan officer-
industry means. Standard errors are reported in parentheses. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.

Dependent variable: Loan officer industry specialization

(1) (2) (3) (4) (5) (6) (7) (8)
Loan Officer characteristics
LO: Number of borrowers 0.001***
(0.000)
LO: Number of industries 0.006
(0.005)
LO: Default rate (pre-reallocation period) 0.001
(0.002)
Loan Officer-Industry characteristics
LO-I: Expertise 0.522***
(0.015)
LO-I: Number of borrowers 0.010***
(0.000)
LO-I: Portfolio share 0.778***
(0.033)
LO-I: Internal credit rating 0.009
(0.007)
LO-I: Credit line interest rate -0.003
(0.006)

Constant YES YES YES YES YES YES YES YES

Observations 417 417 417 417 417 417 417 417
R² 0.029 0.004 0.000 0.745 0.828 0.575 0.005 0.000

56
Table 2. Explaining loan officer industry specialization (continued)
Dependent variable: Loan officer industry specialization
(9) (10) (11) (12) (13) (14) (15) (16)
LO-I: Credit line limit 0.011***
(0.003)
LO-I: Collateral value 0.007**
(0.003)
LO-I: Credit line debt 0.007**
(0.003)
LO-I: Nominal loan amount -0.001
(0.002)
LO-I: Firm age -0.000
(0.001)
LO-I: Distance -0.001
(0.000)
LO-I: Duration 0.001
(0.001)
LO-I: Competition -0.001
(0.002)

Constant YES YES YES YES YES YES YES YES

Observations 417 417 417 417 417 417 417 417
R² 0.030 0.012 0.013 0.001 0.000 0.005 0.002 0.001

57
Table 3. Explaining the change in loan officer specialization
This table displays results from OLS regressions explaining variations in the change in loan officer industry specialization throughout the borrower reallocation
period (7/2007-7/2008). Explanatory variables represent key loan officer (LO) or loan officer-industry (LO-I) characteristics. Characteristics are measured in the
month before the reallocation period if not stated otherwise. Loan officer-industry characteristics based on borrower-level information are calculated as loan officer-
industry means. Standard errors are reported in parentheses. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.

Dependent variable: Loan officer specialization change

(1) (2) (3) (4) (5) (6) (7) (8)
Loan Officer characteristics
LO: Number of borrowers 0.010
(0.012)
LO: Number of industries -0.261
(0.312)
LO: Default rate (pre-reallocation period) -0.122
(0.159)
Loan Officer-Industry characteristics
LO-I: Loan officer industry specialization -8.033**
(3.188)
LO-I: Number of borrowers -0.028
(0.035)
LO-I: Portfolio share -5.453*
(3.285)
LO-I: Internal credit rating -0.409
(0.443)
LO-I: Credit line interest rate -0.252
(0.409)

Constant YES YES YES YES YES YES YES YES

Observations 417 417 417 417 417 417 417 417
R² 0.002 0.002 0.001 0.015 0.002 0.007 0.002 0.001

58
Table 3. Explaining the change in loan officer specialization (continued)
Dependent variable: Loan officer specialization change
(9) (10) (11) (12) (13) (14) (15) (16)
LO-I: Credit line limit 0.067
(0.200)
LO-I: Collateral value -0.026
(0.205)
LO-I: Credit line debt 0.191
(0.196)
LO-I: Nominal loan amount 0.107
(0.153)
LO-I: Firm age -0.012
(0.033)
LO-I: Distance -0.046*
(0.025)
LO-I: Duration 0.010
(0.071)
LO-I: Competition 0.168
(0.133)

Constant YES YES YES YES YES YES YES YES

Observations 417 417 417 417 417 417 417 417
R² 0.000 0.000 0.002 0.001 0.000 0.008 0.000 0.004

59
Table 4. Summary statistics for treatment and control groups
This table displays summary statistics for the matching variables by treatment and control groups in the pre-reallocation period (1/2006-6/2007) based on the
matched samples. Propensity score matching using the Epanechnikov kernel is employed. The treatment (-) [treatment (+)] group contains borrowers who
experience a negative [positive] shock to loan officer industry specialization throughout the borrower reallocation period (7/2007-7/2008). Borrowers whose
specialization levels exhibit only a minor negative [positive] change due to the reallocation form the control (-) [control (+)] group. The differences in means are
assessed with the two-tailed t-test. ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively.

Treatment Control Treatment (-) Treatment Control Treatment (+)

(-) (-) - Control (-) p-value (+) (+) - Control (+) p-value
N (number of borrowers in group) 1,313 1,207 1,130 1,100
Internal credit rating 3.834 3.850 -0.016 0.838 3.503 3.519 -0.016 0.841
Credit line interest rate 11.092 11.082 0.009 0.878 11.207 11.155 0.052 0.385
Credit line limit 8.997 9.017 -0.019 0.889 8.892 8.939 -0.046 0.748
Collateral value 3.243 3.231 0.012 0.950 2.895 2.986 -0.090 0.644
Credit line debt 5.004 5.081 -0.076 0.697 4.632 4.604 0.028 0.891
Nominal loan amount 3.435 3.322 0.112 0.605 4.542 4.534 0.008 0.975
Firm age 33.108 33.370 -0.261 0.781 36.446 36.894 -0.448 0.652
Distance: Round trip travel time (in minutes) 38.795 39.939 -1.144 0.218 30.296 29.875 0.421 0.538
Duration: Relationship length with bank (in years) 18.437 18.468 -0.030 0.948 17.453 17.989 -0.536 0.297
Competition: Competing branches 18.226 18.029 0.196 0.416 18.319 18.407 -0.087 0.730
Industry: Agriculture 0.047 0.054 -0.007 0.424 0.072 0.078 -0.006 0.590
Industry: Utilities 0.020 0.007 0.013*** 0.000 0.000 0.000 0.000 1.000
Industry: Manufacturer 0.042 0.040 0.002 0.800 0.115 0.117 -0.002 0.883
Industry: Construction 0.071 0.076 -0.004 0.631 0.090 0.078 0.012 0.308
Industry: Retail 0.364 0.368 -0.004 0.835 0.114 0.117 -0.003 0.825
Industry: Logistics 0.074 0.076 -0.002 0.849 0.046 0.042 0.004 0.646
Industry: Finance/Insurance 0.018 0.018 0.000 1.000 0.010 0.011 -0.001 0.820
Industry: Housing 0.045 0.042 0.003 0.711 0.092 0.097 -0.004 0.686
Industry: Other services 0.211 0.208 0.003 0.853 0.176 0.188 -0.012 0.462
Industry: Non-profit 0.109 0.111 -0.002 0.873 0.285 0.273 0.012 0.528

60
Table 5. Loan officer specialization change and credit default rates
This table displays results from OLS regressions explaining variations in credit default rates based on the continuous
treatment variable loan officer specialization change. This variable captures the change in loan officer industry
specialization a borrower exhibits throughout the borrower reallocation period (7/2007-7/2008). It takes the value of
zero for all borrowers before the reallocation period and the respective specialization change in the post-reallocation
period. Controls include the pre-reallocation industry specialization quartile a loan officer belongs to. Further controls
(internal credit rating, duration, distance, firm age, competition) are measured as pre-reallocation period means.
Coefficients are scaled and should be interpreted as basis points. Standard errors are reported in parentheses and are
two-way clustered (time and loan officer-industry level). ***, **, and * indicate significance at the 1%, 5%, and 10%
levels, respectively.

(1) (2) (3) (4)

Defaultt+1 Defaultt+1 Defaultt+1 Defaultt+1
Loan officer specialization change -17.978*** -13.707*** -15.613*** -14.092***
(3.397) (3.178) (5.424) (5.285)
Post 8.902*** 9.165***
(2.487) (2.536)

Constant YES YES YES YES

Loan officer x Time FE NO NO YES YES
Industry x Time FE NO NO YES YES
Region x Time FE NO NO YES YES
Size x Time FE NO NO YES YES
Controls NO YES NO YES
Observations 220,100 220,100 220,100 220,100
R² 0.000 0.001 0.026 0.027

61
Table 6. Shocks to loan officer specialization and credit default rates
This table displays results from OLS regressions explaining variations in credit default rates based on the matched
samples. The treatment (-) [treatment (+)] group contains borrowers who experience a negative [positive] shock to
loan officer industry specialization throughout the borrower reallocation period (7/2007-7/2008). Borrowers whose
specialization levels exhibit only a minor negative [positive] change due to the reallocation form the control (-)
[control (+)] group. Post is a dummy variable that indicates the post-reallocation period (8/2008-12/2012). Controls
include the pre-reallocation industry specialization quartile a loan officer belongs to. Further controls
(internal credit rating, duration, distance, firm age, competition) are measured as pre-reallocation period means.
Coefficients are scaled and should be interpreted as basis points. Standard errors are reported in parentheses and are
two-way clustered (time and loan officer-industry level). ***, **, and * indicate significance at the 1%, 5%, and 10%
levels, respectively.

(1) (2) (3) (4)

Defaultt+1 Defaultt+1 Defaultt+1 Defaultt+1
Negative shock to Loan Officer Specialization
Treatment (-) * Post 10.603*** 11.072***
(3.933) (3.925)
Treatment (-) -5.003* -6.051*
(2.643) (3.406)
Positive shock to Loan Officer Specialization
Treatment (+) * Post -8.635** -8.419**
(3.632) (3.640)
Treatment (+) 1.161 1.117
(2.090) (2.300)

Constant YES YES YES YES

Loan officer x Time FE YES YES YES YES
Industry x Time FE YES YES YES YES
Region x Time FE YES YES YES YES
Size x Time FE YES YES YES YES
Controls NO YES NO YES
Observations 113,372 113,372 103,796 103,796
R² 0.048 0.049 0.043 0.044

62
Table 7. Shocks to loan officer specialization and informational value of rating changes
This table displays results from probit regressions predicting post-reallocation borrower defaults for treatment and
control groups based on the matched samples. The time horizon for the default prediction is twelve months. Rating
downgrades [Rating upgrades] capture the cumulated number of negative [positive] rating changes at the borrower
level since the reallocation period (7/2007). Firm level clustered standard errors are reported in parentheses. ***, **,
and * indicate significance at the 1%, 5%, and 10% levels, respectively.
(1) (2) (3) (4)
Defaultt+12 Defaultt+12 Defaultt+12 Defaultt+12
Treatment (-) Control (-) Treatment (+) Control (+)
Rating downgrades -0.012 0.073 0.128*** -0.012
(0.037) (0.047) (0.032) (0.036)
Rating upgrades -0.095** -0.162 -0.270*** -0.179***
(0.042) (0.100) (0.089) (0.066)
Constant YES YES YES YES
Observations 37,795 34,732 33,917 33,098
McFadden R² 0.017 0.023 0.049 0.035
R² relative to control -0.274 0.409

63
Table 8. Shocks to loan officer specialization and loan volumes
This table displays results from OLS regressions explaining variations in nominal loan amounts based on the matched
samples. The treatment (-) [treatment (+)] group contains borrowers who experience a negative [positive] shock to
loan officer industry specialization throughout the borrower reallocation period (7/2007-7/2008). Borrowers whose
specialization levels exhibit only a minor negative [positive] change due to the reallocation form the control (-)
[control (+)] group. Post is a dummy variable that indicates the post-reallocation period (8/2008-12/2012). Controls
include the pre-reallocation industry specialization quartile a loan officer belongs to. Further controls
(internal credit rating, duration, distance, firm age, competition) are measured as pre-reallocation period means.
Standard errors are reported in parentheses and are two-way clustered (time and loan officer-industry level). ***, **,
and * indicate significance at the 1%, 5%, and 10% levels, respectively.

(1) (2) (3) (4)

Nominal Nominal Nominal Nominal
loan amount loan amount loan amount loan amount
Negative shock to Loan Officer Specialization
Treatment (-) * Post 0.473** 0.425*
(0.217) (0.217)
Treatment (-) 0.285 0.036
(0.253) (0.313)
Positive shock to Loan Officer Specialization
Treatment (+) * Post -0.573** -0.549**
(0.265) (0.265)
Treatment (+) 0.160 0.134
(0.413) (0.441)

Constant YES YES YES YES

Loan officer x Time FE YES YES YES YES
Industry x Time FE YES YES YES YES
Region x Time FE YES YES YES YES
Size x Time FE YES YES YES YES
Controls NO YES NO YES
Observations 113,372 113,372 103,797 103,797
R² 0.128 0.138 0.126 0.136

64