The Human Factor in Corporate Loan Quality

The syndicated loan market is one of the largest sources of financing for U.S. firms. This market has experienced tremendous growth over the past 20 years. In fact, some recent estimates suggest that U.S. firms obtain over $1 trillion in new syndicated loans each year and that this represents more than 50 percent of total equity and debt issuances.[1],[2]

The primary players in the syndicated loan market are large banks that have developed strong reputations over time, likely due to their performance in issuing high quality loans. These banks employ loan officers and corporate bankers who screen corporate borrowers and then monitor these borrowers’ performance after loan issuance. However, it is not clear how much these individuals’ decisions contribute to the overall banks’ reputation and performance.

On the one hand, lending decisions and monitoring involve a significant amount of judgment and “soft information” that is often difficult to explicitly quantify in a contract. For example, a loan officer may rely on her past intuition and experience regarding what works in different deals, or make lending decisions based on his or her subjective assessments of management or culture of the firm.[3] This type of information is generally difficult to quantify, thus making individual judgment important. Moreover, individual judgment has likely become increasingly important over time as firms and financial statements become more complex.

On the other hand, significant technological improvements over the past two decades have also improved the lending process. In general, advances in information technology have facilitated tremendous growth in the financial services industry.[4] Banks have embraced these advances by employing sophisticated statistical models to judge the creditworthiness of their borrowers, much like ratings agencies. This technology can potentially automate much of the lending process as it generates internal ratings of a borrower’s solvency and liquidity and leaves little room for loan officer judgment. Moreover, massive consolidation and stricter regulations in the financial services industry have also created hierarchical institutions in which it may be difficult for loan officers to quantify their subjective opinions of borrowers and obtain approval from upper management.

In our recent paper, available here, we attempt to address these issues by examining whether and to what extent loan officers influence the performance of loans issued in large corporate banking departments over and above the banks’ own institutional effect. Examining this issue is generally difficult for researchers, given that data on loan officer identities are not readily available. To circumvent this challenge, we downloaded over 6,000 loan agreements attached to firms’ SEC filings and extracted loan officer signatures from these filings. We appended this data to detailed information on loans as well as bank identities from large academic databases. We also collected data from LinkedIn to examine other individual characteristics of loan officers. Our final sample contains 4,215 loan agreements signed by 7,892 loan officers employed by 982 banks over the 18 year period spanning 1994 to 2012. To our knowledge, it is one of the most comprehensive datasets on loan officers constructed to date.

We begin with a very basic question: Do loan officers exhibit consistent performance over time independent of their affiliations? Given that we observe loan officers at different banks across our sample period, we are able to examine how correlated their lending performance is over time, controlling for the banks they work for. We find that loan officers that write better performing loans in the current period (i.e., more profitable and less likely to default) are more likely to do so in the future, even after moving to another bank. This provides initial evidence that loan officers appear to influence the screening and monitoring of borrowers, as their performance persists over time and across different banks.

We next try to quantify how important a loan officer is in comparison with the institution where he or she works. To do so, we employ new statistical methods from the field of econometrics that have allowed researchers to compare the importance of employees to the firm. Our estimates suggest that loan officers are up to six times more important in explaining loan performance than are the banks that employ them. These findings are consistent with judgment and individual loan officer styles playing an important role in influencing lending outcomes.

Given the importance of loan officers in influencing lending performance, we next try to examine how they achieve this persistent performance. We consider three important lending terms that loan officers might be able to influence and thus might reflect their lending styles. First, we consider the pricing terms of the loan, which is the spread between loan interest rates and LIBOR. Second, we consider two non-pricing terms of the loan, which are the number of covenants that restrict borrowers’ behavior and the term of the loan. Our findings indicate that loan officers have significant influence over the costs and stringency of loan contracts. In fact, depending on the specific terms, we find that loan officers appear to be at least five times more important than the institution in setting loan contracts.

Moreover, we find substantial patterns in how loan officers write different loans. Some loan officers appear to issue loans with systematically lower spreads and higher covenants, and these loans tend to perform better. This suggests that a conservative lending style on loan officers’ part is an important factor in explaining their incremental importance to the institution.

Finally, we try to identify what aspects of loan officers’ background allow them to exhibit individual judgment and unique styles. In terms of individual characteristics, we examine data from LinkedIn, including loan officers’ educational backgrounds, gender, and career history. We find that the starting point of one’s career is the most important determinant in explaining how loan officers develop their styles. In terms of bank characteristics, we find that individual style and judgment is important in both small and large banks. However, loan officers appear to be given more discretion in setting lending terms within large institutions. This is perhaps consistent with large institutions placing a greater reliance on individual judgment as they lend to more complicated firms and have more hierarchical structures that value individual judgment.

Overall, our study provides evidence of a human factor in corporate lending. Our findings suggest that judgment is not easily automated and that banks rely heavily on loan officers’ soft information acquired through their careers in setting loan terms. This finding should shed light on the important role of individual judgment in increasingly complicated financial markets.


[1] Weidner, D., 2000. “Syndicated lending closes out 90s on a tear.” American Banker January 10th, 1.

[2] Wittenberg-Moerman, 2008. “The role of information asymmetry and financial reporting quality in debt trading: Evidence from the secondary loan market.” Journal of Accounting and Economics 46: 240-260.

[3] Berger, Allen N. and Gregory F. Udell, 2004. “The institutional memory hypothesis and the procyclicality of bank lending behavior.” Journal of Financial Intermediation 13: 458-495.

[4] Berger, Allen B., 2003. “The Economic Effects of Technological Progress: Evidence from the Banking Industry.” Journal of Money, Credit, and Banking 35: 141-176.

This post comes to us from Janet Gao and Joseph Pacelli, Professors at Indiana University’s Kelley School of Business and Professor Xiumin Martin at Washington University’s Olin Business School. It is based on their recent article, “What Begets Loan Performance? The Human Factor in the Corporate Lending Market,” available here.