Managerial risk taking incentives, relationship lending and cost of debt

Abstract

This paper provides empirical evidence on how lending relationships can impact lending banks’ sensitivities to managerial risk taking incentives. Bank loans with higher managerial risk taking incentives will carry higher loan spreads, all else being equal. However, relationship lending can reduce the lending banks’ sensitivities to managerial risk taking incentives by 36% on average in terms of loan spreads. Such impact is more pronounced in firms with a higher information opacity level. Overall, our results imply that lending relationships play an important role in mitigating agency cost of debt from managerial risk taking incentives.