Our speaker will be Karin S. Thorburn (Norwegian School of Economics.

She will give a talk on “Bank Compensation for the Penalty-Free Loan-Prepayment Option: Theory and Tests” (joint work with B. Espen Eckbo and Xunhua Su).

Abstract: Commercial and industrial bank loans typically include an option to prepay the loan without penalty (zero cancellation fee). We present a first analysis of how banks must be compensated for this option. Borrowers use the loan to fund investment projects and subsequently receive non-contractible information about project payoff. As high-quality borrowers self-select to prepay, the credit-quality of the bank’s borrower pool deteriorates. Hence, to avoid credit rationing, the bank must be compensated upfront with a minimum upfront fee combined with a lower loan spread. The upfront fee dominates the alternative of a cancellation fee as the latter gives rise to opportunistic ex post bargaining with the bank’s preferred clients. Large-sample tests, which include exogenous industry-level variation in loan prepayment risk, confirm that upfront fees increase with prepayment risk and are lower in credit lines and loans with performance-sensitive pricing, as predicted.

The talk will take place on June 1, 2023 at 12:00 noon in room D3.0.225