Organizational Complexity and Bank Loan Spreads

This study examines whether and how organizational complexity arising from the legal fragmentation of the firm into multiple entities affects the interest spread charged on bank loans and the design of loan contracts. The legal fragmentation of the firm is bound to be a consideration lenders make in determining the pricing of debt and design of contract terms because, for instance, lenders can only enter into legally enforceable agreements with specific legal entities. I document that organizational complexity is associated with higher loan spreads and the use of debt covenants and other loan terms. The relation between complexity and loan spreads is more pronounced for loan characteristics that reflects higher risk, but is attenuated by contracting mechanisms. Yet, contracts in the sample do not always include terms that mitigate contracting risks from organizational complexity. Subsequent tests are suggestive of potential channels related to credit quality and control rights.