FASB disclosure and bank loan contracting: evidence from derivative and hedging footnotes

This paper examines the economic consequences of mandated disclosure changes due to the issuance of SFAS 161 in 2008. Despite the importance of understanding the aspects of firms’ disclosures for their stakeholders, little is known about how the price terms and non-price terms of loan contracts are structured in response to SFAS 161. I employ a difference-in-differences design to evaluate 3,732 bank loans for 1,126 firms in the United States over the 2002-2017 sample period. I conduct a textual analysis to quantify the characteristics of disclosure changes under SFAS 161, addressing (1) whether these mandated changes improve lenders’ understanding, (2) through which channels the implementation of SFAS 161 disclosure requirements affect loan terms, and (3) what characteristics (format vs. content) most inform lenders’ understanding. I find that firms whose disclosures change more after SFAS 161 are associated with lower loan spreads, fewer general covenants, and less stringent but more accounting-based financial covenants. The results from channel tests indicate that the decrease in loan spreads and covenant tightness are driven by the resolution of information uncertainty with respect to the firm value. In contrast, the changes in the number of general and financial covenants are associated with the improvement in financial reporting quality. These effects persist after controlling for confounding real effects, suggesting that the results are not driven by potential changes in firms’ derivative and hedging behavior due to the financial crisis and/or SFAS 161. Overall, these findings suggest that the mandated disclosure changes improve lenders’ understanding. In particular, enhanced qualitative and quantitative disclosures and more tabular display after SFAS 161 matter most for lenders.