It’s surprisingly tough to find detailed information about the loan agreements of many public companies. In fact, nearly 20 percent of those agreements are not publicly available, despite disclosure mandates. In a recent study, we shed light on this phenomenon, revealing a deliberate decision-making process that influences which details become public and which remain under wraps.

The heart of the issue lies in what we term “disclosure-related costs.” It’s a concept that describes why companies might choose to hide the nitty-gritty of their loan covenants. Prior research reveals that, for many loans, companies are often constrained by tight initial covenants, giving lenders more control. However, these covenants can and often do get renegotiated to more favorable terms for the borrower. Disclosing these stringent, initial terms could alarm other lenders, like trade creditors or bondholders, who might then act to protect their interests by, say, pulling their financing, potentially harming the company’s liquidity and negotiating leverage.

Through an examination of a broad sample of loans, we document that companies are significantly more secretive about their loan covenants when they anticipate tighter constraints and frequent renegotiations, especially when under the scrutiny of trade creditors or other lenders. This behavior is a strategic move to sidestep potential adverse reactions that could hurt the business before any renegotiation can occur. Essentially, it’s about managing the narrative and controlling how much outsiders know so that companies can navigate financial challenges more smoothly.

We obtain our comprehensive sample from DealScan, using as a measure of disclosure whether companies released their full loan contracts in SEC filings. We find that only about 80.5 percent of loans were fully disclosed. Through further analyses, including looking at the strength and duration of company-bank relationships and various other factors, our study corroborates its hypothesis that companies withhold details to avoid negative reactions from other capital providers.

We take a robust approach to ruling out other potential reasons for nondisclosure, such as the materiality of the loan or the desire to only share good news. The findings hold up across different cuts of the data, pointing squarely at the strategic withholding of information as a response to anticipated tight covenants and renegotiation.

Our research offers finance professionals a new perspective on corporate disclosure practices, especially concerning loan agreements. It highlights the strategic considerations companies make in disclosing their information, driven by the need to carefully navigate their financial obligations.

For regulators and compliance professionals, these findings add a layer of complexity to the oversight of disclosure practices. They challenge the assumption that nondisclosure is purely a matter of oversight or regulatory noncompliance, pointing instead to a calculated strategy in managing corporate finance. This casts doubt on the effectiveness of a one-size-fits-all approach to mandating full disclosure of loan agreements, which clearly carry significant costs that, which companies are fully aware of — and take steps to avoid.

This post comes to us from Edward Xuejun Li and Monica Neamtiu at the City University of New York’s Baruch College and Zhiyuan Tu at the Southwestern University of Finance and Economics. It is based on their recent article, “Do Firms Withhold Loan Covenant Details?” available here.