Price Discovery and Dissemination of
Private Information by Loan Syndicate
Participants
Robert M. Bushman
Abbie J. Smith
Regina Wittenberg-Moerman
Research questions
Objective: To better understand the relation between information
flows and the price discovery process in the loan and stock markets.
 What are the determinants of the speed of price discovery in the syndicated
loan market?
 Explore the importance of syndicate structure and loan contractual
terms in the price discovery process.
 Provide insight into the timing of private information dissemination by
borrowers to lenders.
 Is price discovery in equity markets affected by the dissemination of a
borrower’s private information?
 Establish cross-market relations in price discovery driven by a firm’s
debt agreements.
 Explore the possibility that private information received in the loan
market is exploited for insider trading in the stock markets.
The syndicated loan market
 The syndicated loan market:
 Primary loan market – market where syndicated loans are originated.
 Secondary loan market – market where syndicated loans are
subsequently traded.
 Syndicated loan - loan provided by a group of lenders and is structured
and managed by one or several banks known as arrangers.
 Main secondary loan market participants - banks, loan participation
mutual funds, Collateralized Loan Obligations, finance companies,
pension funds and hedge funds.
• Rapid growth of the syndicated loan market:
 Starting in 1999, U.S. firms have obtained over $1 trillion in new
syndicated loans each year, with $1.7 trillion in 2007.
 Significant entry of nonbank institutional investors into the syndicated
loan market.
Information distribution in the
syndicated loan market
 Syndicate participants receive confidential information:
 Financial disclosures, covenant compliance reports, amendment and
waiver requests, financial projections, plans for acquisitions.
 Traded loans are not considered securities and thus are not governed
by the Securities Acts of 1933 and 1934.
 Syndicate participants can generally trade on syndicate-confidential
information in a manner consistent with the appropriate standards of
professional integrity and fair dealing:
 The informed participant is expected to offer to reveal syndicateconfidential information to a counterparty.
 Unless the informed participant reasonably believes that the
counterparty has already received the information or the counterparty is
sophisticated and understands the nature and importance of syndicateconfidential information.
Information distribution in the
syndicated loan market (cont’d.)
 Rule 10b-5 prohibits the purchase or sale of a security on the basis
of material nonpublic information.
 Strategies for dealing with the conflict between the public and
private sides of the information wall:
 “Chinese walls” - traders, salespeople and analysts do not receive
private information.
 Written procedures that preclude trading on private information received
from the loan market.
 The whole firm is kept on the public side by agreeing not to receive any
material non-public information.
 Concern: Syndicate participants (nonbank institutional investors, in
particular) exploit their access to private information to engage in
insider trading.
Anecdotal evidence
 Standard & Poor’s (2007):
 “…growing concern among issuers, lenders, and regulators that this migration
of once private information into public hands might breach confidentiality
agreements between lenders and issuers and, more importantly, could lead to
illegal trading”.
 “…mark-to-market pricing services often report significant movement in a loan
price without any corresponding news. This is usually an indication that the
banks have received negative or positive information that is not yet public”.
 Institutional press on hedge funds:
 [They] “use the same professional to trade all the financial instruments across a
company's capital structure”.
 “You can't put a Chinese wall through someone's head”.
 “A hedge fund gets into the loan business by buying very small amounts of loan
syndications … to get access to any information a bank would have access to”.
 Movie Gallery:
 Over the two days after a confidential conference call with lenders, despite the
absence of any public news releases, the stock price dropped by 25%.
Prior research
 Cross-market lead-lag relations:
 Acharya and Johnson (2007): informed lenders exploit private information
gleaned from clients to inside trade in the credit default swap market.
 Allen and Gottesman (2006), Allen et al. (2004), Altman et al. (2008),
Blanco et al. (2005), Hotchkiss & Ronen (2002), Longstaff et al. (2003) and
Norden and Weber (2004).
 Insider trading by informed lenders:
 Ivashina and Sun (2007): institutional managers who participate in loan
renegotiations trade in the firm’s stock and outperform other managers
in the month following the loan renegotiation.
 Massa and Rehman (2005): following a loan deal, the mutual funds of
the conglomerate profitably adjust their stakes in the firms that borrow
from the affiliated banks.
 The role of institutional investors in the loan market:
 Gatev and Strahan (2008), Jiang et al. (2008), Nandy and Shao (2007), Nini
(2008).
Research design
 Price discovery in the secondary loan market:
 The direct flow of confidential information to loan market participants is
likely to dominate price discovery in the loan market.
 Characteristics that potentially influence the timing of private information
dissemination:
Relationship lending (Bharath et al., 2006, Sufi, 2007)
Reputation of the arranger of syndication (Jones et al., 2005, Dennis
and Mullineaux, 2000, Lee and Mullineaux, 2004, Sufi, 2007)
Covenants (Allen et al., 2004, Standard & Poor’s, 2007, Bradley and
Roberts, 2004).
 Price discovery in the stock market:
 Investigate whether price discovery in the stock market is timelier for
firms with syndicated loan characteristics associated with relatively early
private information dissemination from borrowers to lenders.
Information flows in the loan and
stock markets
The measure of intra-period timeliness
 Focus on the 63-trading-day time period that begins 60 trading days
before and ends two trading days after firms’ quarterly earnings
announcements.
 Construct portfolios of firm-quarter observations based on firm and loan
characteristics.
 Intra-period timeliness is estimated by the area under the curve
constructed by plotting for each of the 63 trading days in the period the
cumulative buy-and-hold abnormal return up to that day, scaled by the
cumulative buy-and-hold abnormal return for the whole period.
1
1 2
IPT   ( BH m 1  BH m ) / BH 2   ( BH m / BH 2 )  0.5
2 m 60
m 60
 The statistical test establishes whether the curves for the two portfolios
are statistically different from each other in a way that is consistent with
differential price discovery.
Plot of IPT-loan-return for Relationship-lending
and Non-Relationship-lending portfolios
Statistical test of differences in intraperiod timeliness
 The notion of the timeliness of information arrival:
A higher proportion of the total cumulative abnormal return for the “fast”
price discovery portfolio will occur earlier in the period relative to the
“slow” price discovery portfolio.
 That is, the order of arrival of the observed returns is crucial, because
information would arrive relatively earlier for the timely portfolio and
relatively later for the less timely one.
 A permutation analysis is used to construct the distribution of the test
statistic under the null that the ordering of return arrivals does not matter:
 Randomize the ordering of the 63 return pairs (one return for each
portfolio for each day) 1000 times, computing IPT for each iteration,

 Use sampling distribution to indicate the likelihood of observing  IPT
under the null hypothesis.
Data
 Loan Trade Database (Secondary loan trading)
 Bid and ask price quotes, quote date and the number of market makers reporting
price quotes.
 DealScan (Primary loan market data)
 Loan and syndicate characteristics, such as amount, covenants and syndicate
structure.
 Standard & Poor’s historical database
 Credit ratings, watch list and outlook at the firm level.
 Mergent FISD
 Moody’s, Fitch or DPR Credit ratings at the firm level.
 COMPUSTAT, CRSP, IBES, First Call
Plot of IPT-loan-return for Reputable-arranger
and Non-Reputable-arranger portfolios
Plot of IPT-loan-return for Covenant and
Non-Covenant portfolios
IPT-loan-return for portfolios based on firm and
loan characteristics
Portfolio 1
(1)
IPT-loan-return
Portfolio 2
Difference
(2)
(3)
Percentile IPT
(4)
Informational features of
lending arrangement
Relationship-lending
30.03
(2,603)
18.43
(2,178)
11.60**
98.42
Reputable-arranger
29.78
(2,712)
25.23
(2,069)
4.55**
95.02
Covenant
28.26
(4,240)
23.45
(541)
4.81**
96.18
29.69
(2,685)
27.28
(2,096)
2.41
54.82
33.26
(1,620)
22.94
(2,719)
10.32**
96.25
DLI
34.32
(1,973)
25.52
(1,973)
8.80**
95.64
DLI-increase
34.30
(1,730)
29.23
(2,136)
5.07
84.18
Size
33.57
(2,388)
26.65
(2,393)
6.92**
97.46
Income-positive
23.19
(3,093)
31.49
(1,688)
-8.30**
95.31
Analyst-coverage
31.05
(4,114)
28.79
(667)
2.26
56.80
Analyst-dispersion
27.58
(1,903)
31.00
(1,894)
-3.42
61.16
30.82
(526)
27.88
(4,255)
2.94
58.76
Institutional Lending
Institutional
Default risk
Credit-rating
Information transparency
Management-forecast
The impact of the information features of lending
arrangements, controlling for firm and loan characteristics
Portfolio 1
(1)
IPT-loan-return
Portfolio 2
Difference
(2)
(3)
Percentile IPT
(4)
Relationship-lending
Size above median
36.21
(1,384)
23.22
(1,004)
12.99**
95.98
Size below median
32.25
(1,219)
21.66
(1,174)
10.59**
95.21
Tangibility above median
36.69
(1,342)
24.32
(991)
12.37**
96.25
Tangibility below median
28.77
(1,261)
19.86
(1,187)
8.91**
95.13
Size above median
33.16
(1,623)
26.36
(765)
6.80**
97.68
Size below median
27.78
(1,089)
22.87
(1,304)
4.91*
93.54
Number-of-market-makers
above median
35.21
(1,545)
29.08
(940)
6.13**
97.07
Number-of-market-makers
below median
25.35
(1,167)
23.76
(1,129)
1.59
34.80
Credit-rating above median
35.93
(2,354)
31.38
(244)
4.55*
92.76
Credit-rating below median
24.31
(1,508)
20.13
(233)
4.18
84.75
DLI above median
36.53
(1,777)
31.18
(196)
5.35**
96.00
DLI below median
25.22
(1,731)
22.53
(242)
2.69
29.16
Reputable-arranger
Covenant
IPT-stock-return for portfolios based on firm and
loan characteristics
Portfolio 1
(1)
Informational features of
lending arrangement
Relationship-lending
IPT-stock-return
Portfolio 2
Difference
(2)
(3)
Percentile IPT
(4)
28.51
(20,962)
26.89
(33,595)
1.62
46.29
Reputable-arranger
32.56
(18,182)
27.32
(36,375)
5.24
76.19
Covenant
27.58
(39,327)
25.17
(15,230)
2.41
38.15
Institutional Lending
Institutional
38.07
(6,604)
23.32
(47,953)
14.75**
98.43
39.85
(4,781)
24.77
(49,776)
15.08***
99.15
34.71
(11,328)
24.89
(13,281)
9.82**
97.60
DLI
33.06
(23,611)
28.36
(23,611)
5.70*
93.86
DLI-increase
29.09
(22,075)
25.95
(24,242)
3.14
64.39
26.87
(27,274)
28.16
(27,283)
1.29
28.60
Income-positive
22.13
(39,391)
25.70
(15,166)
-3.57
63.74
Analyst-coverage
31.07
(40,307)
29.32
(14,250)
1.75
53.48
Analyst-dispersion
25.86
(16,333)
34.62
(16,675)
-8.76**
96.25
Management-forecast
31.87
(3,332)
23.27
(51,225)
8.60**
95.10
Trading on the secondary
loan market
Loan-trading
Default risk
Credit-rating
Information transparency
Size
IPT-stock-return for institutional portfolio
• The total sample of institutional loans
Portfolio 1
(1)
IPT-stock-return
Portfolio 2
Difference
(2)
(3)
Percentile IPT
(4)
Relationship-lending
42.84
(3,166)
31.04
(3,438)
11.80**
95.79
Arranger-reputation
44.35
(2,532)
32.38
(4,072)
11.97**
97.09
Covenant
43.14
(5,222)
24.96
(1,382)
18.18***
99.20
• Institutional loans after excluding traded loans
Portfolio 1
(1)
IPT-stock-return
Portfolio 2
Difference
(2)
(3)
Percentile IPT
(4)
Relationship-lending
41.13
(1,646)
29.54
(2,273)
11.59**
95.11
Arranger-reputation
45.68
(1,005)
29.99
(2,914)
15.69**
97.91
Covenant
41.24
(2,815)
25.44
(1,104)
15.80**
95.28
IPT-stock-return for institutional and non-institutional
portfolios, controlling for firm characteristics
Institutional
(1)
IPT-stock-return
Non-institutional
Difference
(2)
(3)
Percentile IPT
(4)
Credit-rating above median
37.58
(4,288)
23.53
(7,040)
14.05**
97.29
Credit-rating below median
23.17
(696)
25.67
(12,585)
-2.50
38.02
DLI above median
38.35
(3,831)
25.22
(19,780)
13.13**
95.09
DLI below median
31.65
(2,100)
25.33
(21,511)
6.32
87.74
Tangibility above median
41.37
(3,528)
27.53
(21,901)
13.84*
93.19
Tangibility below median
35.96
(2,844)
21.65
(22,587)
14.31**
96.52
Analysis of Institutional portfolio, controlling for credit
risk and information transparency measures
IPT-stock-return
IPT-stock-return
Credit risk
Credit-rating above median
37.58
(4,288)
DLI above median
38.35
(3,831)
Credit-rating below median
23.17
(696)
DLI below median
31.65
(2,100)
Difference
Percentile
6.70*
90.85
Difference
Percentile
14.41**
96.75
Firm disclosure
Analyst-dispersion
above median
35.03
(2,615)
With Managementforecast
28.84
(400)
Analyst-dispersion
below median
38.47
(1,959)
Without Managementforecast
40.65
(6,204)
Difference
Percentile
-3.44
45.44
Difference
Percentile
-11.81**
95.44
Conclusions
 Price discovery in the secondary loan market is timelier for
relationship loans, loans syndicated by a reputable arranger and
loans subject to financial covenants.
 Contributes to the literature on secondary loan market trading.
 Timelier dissemination of private information to lenders in the loan
market is associated with faster price discovery in the stock market
when institutional investors are involved in the syndicated loans.
 Extends the literature investigating lead-lag relations between
prices across capital markets.
 Contributes to the literature on insider trading by informed
lenders.
 Complements the literature on the role of institutional investors in
the syndicated loan market.