The Costs of Being Private: Evidence from the Loan Market Anthony Saunders Sascha Steffen (New York University) (University of Mannheim) 45 th Annual Conference on Bank Structure and Competition Federal Reserve Bank of Chicago May 6 th, 2009

Motivation Between , more than 50% of syndicated loans were allocated to private firms. However, research has focused on large, publicly held firms. Literature on “Why do firms go private?” highlight significant gains associated with going-private transactions ignoring borrowing costs once these firms are private. Sufi (2007): 90% of public firms have borrowed in the syndicated loan market; syndicated lending represents 51% of US corporate finance

This Paper Do privately held firms face higher borrowing costs in loan markets than publicly held firms? What are implications relating to borrowing costs for firms remaining or going private? If there is a loan cost disadvantage for private firms, which firms are affected most? Is there a role for relationships in mitigating this loan cost disadvantage?

Our Empirical Setting Unique dataset from 1987 – 2007 relating to U.K. syndicated loans –Since Companies Act in 1964, private and public limited liability companies have to disclose financial statements. Disclosure rules are enforced Statements in accordance with UK GAAP and audited –We have detailed financial statement data for both public and private firms together with the loan characteristics –We match loans to public and private firms based on propensity scores and compare loan spreads to both type of firms

Data and Sample Selection LPC Dealscan database, Bureau van Dijk’s Amadeus and Thomson’s SDC database to construct unique dataset on U.K. syndicated loans (1987 – 2007) Amadeus has detailed financial statement data for public and private firms which are hand-matched to LPC –We follow each company to identify name changes and changes in corporate legal status (private or public) Final Sample of 1,742 loans to 485 UK based borrowers

Data and Sample Selection (2) We complement the dataset –Stock index affiliation (AIM, FTSE,…) –I/B/E/S for analyst coverage –Amadeus Ownership database for insider ownership –Mergermarket and Factiva to identify private equity involvement Public firms: 81% not private equity backed (17% PtP) Private firms: 34% not private equity backed (49% LBO) –Secondary market trading for loan liquidity 33.5% of all loans are subsequently traded (41.8% of private firm loans)

Key Loan and Borrower Characteristics PrivatePublic Difference (54.8%)(45.2%) Loan Characteristics AISD (basis points) *** Facility Amount ($ million) *** Maturity (months) *** Borrower Characteristics Total Assets ($ million)1,6168,985-7,369 *** Leverage (Debt/Equity) *** Age (years) ***

Propensity Score Matching We address self-selection into being public or private using propensity score matched samples (Rosenbaum/Rubin (1983)) 1.Determinants of (i) being public and (ii) loan spreads 2.Estimate propensity score (probit model) 3.Estimate the effect of being public rather than private on loan spreads –Nearest Neighbor (NN) matching and Local Linear (LL) matching

The Costs of Being Private

The Costs of Being Private (2) Loan cost disadvantages are particularly pronounced in high information asymmetry environments –Stratify matched sample by size and age Results are robust across alternative information proxies MethodologyCoefficientStd. Error OLS-35 *** (9.10) NN Matching-32 *** (8.53) LL Matching-29 *** (10.61)

Loan Spreads & Lending Relationships Do firms benefit from bank-borrower relationships? If so, do public and private firms benefit equally from bank-borrower relationships? A bank is a relationship lender if it had a lead position among the syndicate members in a loan to the same borrower within a 5 year period prior to current loan. We compare loan spread differences between private and public firms for relationship versus non- relationship loans across different firm size quartiles

Loan Spreads & Lending Relationships (2) Public and private firms benefit from relationships –Large public borrowers have greater benefits than small public borrowers. –Public firms (particularly large public firms) benefit more from lending relationships than private firms. –Relationships are particularly valuable for small private firms. Relationship Benefits Public Firms Private FirmsDifference Public Firms Private Firms Small Firms149bps186bps37bps35bps30bps Large Firms88bps113bps25bps62bps22bps

Loan Spreads & Ownership Structure Insider ownership is higher for private firms which leads to enhanced risk taking incentives (Amihud and Lev (1981)) –Positive correlation between ownership and loans spreads but private firms still pay higher spreads Private equity firms use higher leverage which increases bankruptcy risk –Loan spreads are higher in sponsored deals –Private firms still pay higher spreads (even if no private equity firm is involved)

Loan Spreads & Loan Liquidity Liquid markets for loans allows lenders to hedge their exposure (diversification effect) –If loans to private firms are less liquid, investors might demand higher spreads Loans to private firms are more liquid: 41.8% are traded in secondary market (versus 25.9% of loans to public firms) Private firms still pay higher spreads after controlling for loan liquidity

Conclusion Our results suggest that private firms face significant loan cost disadvantages compared to publicly traded firms. Small, opaque private firms are affected the most. The loan cost disadvantage is smaller if firms have a high propensity of being public. Relationships reduce the cost of debt, but public firms benefit more.