Institutional Differences and International Private Debt Markets: A Test Using Mandatory IFRS Adoption

Institutional differences between countries result in additional information risks between borrowers and lenders in cross-border private loans. This study examines the effect of these information risks on the structure of optimal debt contracts in international (cross-border) versus domestic private debt markets. Using mandatory IFRS adoption as an indicator for institutional changes that reduced differences between countries, I compare attributes of international versus domestic loans before and after IFRS adoption. I find that, in the pre-IFRS period, international loans are associated with a higher credit spread, a weaker relationship between the bank and the borrower, a more diffuse loan syndicate, and less reliance on accounting-based covenants than domestic loans. These results are consistent with incremental information risks in international debt markets that make it more costly for lenders to screen and monitor borrower credit quality, resulting in a more arm's-length relationship between borrowers and lenders. Many of these associations attenuate after IFRS adoption, suggesting that the pre-IFRS differences in contract terms are driven by incremental information risks related to institutional differences between countries. My findings imply that incremental information risks result in a different optimal contract in international debt contracts compared to domestic debt contracts.