Lenders' Decision Strategies and Loan Structure Decisions

Abstract Loan structure is an important component of the credit granting process. Loan structure establishes the monitoring relationship between the borrower and lender, affects accounting choices made by the borrower, and influences perceptions of the riskiness of the borrower and lender. Inappropriate loan structures, particularly those that are too restrictive, are noisy signals that could have economic consequences for borrowers and lenders. Based on the theory of cost-benefit tradeoff in decision process selection, this article proposes that the level of decision process effort applied by a lender may affect loan structure restrictiveness. To test this hypothesis, professional loan officers analyzed financial and nonfinancial information of candidate borrowers and set preferred levels of collateral and covenants while their decision processes were captured using computerized process tracing. Consistent with the theory, results showed a negative association between loan structure restrictiveness and two aspects of decision process: the time spent evaluating information and the order in which information was examined (i.e., information search pattern). Loan structure restrictiveness was not associated with the amount of information examined, nor with lenders' risk preferences or years of lending experience. These findings suggest that loan structure decisions may be contingent on the way loan officers analyze information. The implications of these findings for lending research and practice are discussed.

[1]  George Foster,et al.  Financial Statement Analysis. , 1980 .

[2]  Philip Beaulieu,et al.  Commercial Lenders' Use of Accounting Information in Interaction with Source Credibility* , 1994 .

[3]  Paul H. Schurr,et al.  Effects of gain and loss decision frames on risky purchase negotiations. , 1987 .

[4]  Robert S. Billings,et al.  The effects of response mode and importance on decision-making strategies: Judgment versus choice , 1988 .

[5]  Clifford W. Smith.  A perspective on accounting-based debt covenant violations , 1993 .

[6]  A. Abdel-khalik,et al.  Information Choice and Utilization in an Experiment on Default Prediction , 1980 .

[7]  D. G. Pruitt,et al.  NEGOTIATION AND MEDIATION , 1992 .

[8]  R. Sternberg.  Advances in the psychology of human intelligence , 1982 .

[9]  Jean C. Bedard,et al.  The Effects of Task Size and Similarity on the Decision Behavior of Bank Loan Officers , 1985 .

[10]  Jerold B. Warner,et al.  On financial contracting: An analysis of bond covenants , 1979 .

[11]  B. Dosher,et al.  Strategies for multiattribute binary choice. , 1983, Journal of experimental psychology. Learning, memory, and cognition.

[12]  Eric J. Johnson,et al.  Adaptive Strategy Selection in Decision Making. , 1988 .

[13]  J. Ford,et al.  Process tracing methods: Contributions, problems, and neglected research questions , 1989 .

[14]  L. Beach,et al.  A Contingency Model for the Selection of Decision Strategies , 1978 .

[15]  Robert H. Ashton,et al.  Judgment and decision-making research in accounting and auditing: Acknowledgments , 1995 .

[16]  Allen N. Berger,et al.  Collateral, loan quality and bank risk , 1988 .

[17]  Robert J. Sternberg,et al.  Expertise and Intelligent Thinking: When is it Worse to Know Better , 1989 .

[18]  J. Bettman.  An information processing theory of consumer choice , 1979 .

[19]  Mark L. DeFond,et al.  Debt covenant violation and manipulation of accruals , 1994 .

[20]  John W. Payne,et al.  Contingent decision behavior. , 1982 .

[21]  Max H. Bazerman,et al.  Negotiator cognition and rationality: A behavioral decision theory perspective , 1992 .

[22]  Laureen A. Maines.  Judgment and decision-making research in accounting and auditing: Judgment and decision-making research in financial accounting: A review and analysis , 1995 .

[23]  John W. Payne,et al.  Task complexity and contingent processing in decision making: An information search and protocol analysis☆ , 1976 .

[24]  H. Zur,et al.  The effect of time pressure on risky choice behavior , 1981 .

[25]  M. D. Beneish,et al.  The Resolution of Technical Default , 2000 .

[26]  A. Tversky.  Intransitivity of preferences. , 1969 .

[27]  Laurence R. Paquette,et al.  The effect of decision strategy and task complexity on decision performance in an accounting context , 1988 .

[28]  Lisa Koonce,et al.  Investor Reactions to Financial Analysts' Research Reports , 1995 .

[29]  Allen Newell,et al.  Human Problem Solving. , 1973 .

[30]  Andrew J. Rosman,et al.  Methodological issues in judgment and decision-making research: Concurrent verbal protocol validity and simultaneous traces of process. , 1993 .

[31]  J. Edward Ketz,et al.  Financial Ratio Patterns in Retail and Manufacturing Organizations , 1983 .

[32]  M. Lubatkin,et al.  Rigidity in Decision Behaviors: A Within-Subject Test of Information Acquisition Using Strategic and Financial Informational Cues , 1994 .

[33]  J. Stiglitz,et al.  Credit Rationing in Markets with Imperfect Information , 1981 .

[34]  James R. Booth,et al.  Structure and pricing of large bank loans , 1995 .

[35]  T. M. Tripp,et al.  An evaluation of dependent variables in experimental negotiation studies: Impasse rates and pareto efficiency☆ , 1992 .

[36]  M. D. Beneish,et al.  Costs of technical violation of accounting-based debt covenants , 1993 .

[37]  A. P. Sweeney,et al.  Debt-covenant violations and managers' accounting responses , 1994 .

[38]  Eric J. Johnson,et al.  A componential analysis of cognitive effort in choice , 1990 .

[39]  George Kanatas,et al.  Asymmetric Valuations and the Role of Collateral in Loan Agreements , 1985 .

[40]  Merrie Brucks,et al.  Search Monitor: An Approach for Computer-Controlled Experiments Involving Consumer Information Search , 1988 .

[41]  Robin L. Pinkley,et al.  Impact of knowledge regarding alternatives to settlement in dyadic negotiations: Whose knowledge counts? , 1995 .