Internal Governance, Legal Institutions and Bank Loan Contracting around the World

Using a sample of non-U.S. borrowers from 22 countries during 2003–2007, we examine the effect of firm-level governance on various features of loan contracting in the international loan market. We find that banks charge lower loan rates, offer larger and longer-maturity loans and impose fewer restrictive covenants to better-governed firms. We also find that the favourable effect of firm-level governance on some loan contracting terms are stronger in countries with strong legal institutions than in countries with weak legal institutions. Our results suggest that banks view a borrower’s internal governance as a mitigating factor for agency and information risk, and that country-level legal institutions and firm-level governance mechanisms complement each other in influencing loan contracting terms.