Businesses face hidden loan costs after going public

By Kevin Manne

Going public can help a company get better loan terms and more easily borrow from different banks, but new research from the University at Buffalo School of Management reveals that newly public firms can face hidden loan costs.

Available online ahead of publication in the Journal of Corporate Finance, the study found businesses that go public are more likely to face performance-based loan agreements that can raise interest rates if the company’s financial performance declines. 

“When a company goes public, it becomes more transparent and more attractive to new lenders, but they remain skeptical,” says study co-author Luca Lin, PhD, assistant professor of finance in the UB School of Management. “A firm’s existing lenders learn a lot about the company through their relationships — things like how managers behave during financial distress, what the corporate culture is like, or information from monthly financial updates or internal forecasts. To earn the trust of new lenders who don’t have access to this information even after an IPO, businesses often have to accept loan terms that punish poor performance, even if their risk profile hasn’t changed.”

To analyze how a company going public affects borrowing, the researchers analyzed more than 2,200 loans issued to more than 400 newly public U.S. firms between 1994 and 2019, comparing loans made in the three years before and after each initial public offering. 

Using detailed contract data, firm financials and filings from the Securities and Exchange Commission, the authors applied fixed-effects regression models to examine how loan terms — particularly performance-sensitive pricing — differ based on lender relationships and firm characteristics.

Their findings show that after an IPO, companies are 54% more likely to receive a loan with an “interest-increasing performance pricing” clause, but only from new lenders. Lenders who already have a relationship with the firm don’t require the same terms.

Despite the added pressure, the researchers found that firms are still 20% more likely to switch lenders after going public — and that these stricter, performance-based terms are rarely triggered in practice and often get renegotiated once lenders gain confidence in the firm. 

“Firms want to escape the grip of existing lenders and diversify their financing sources, but doing so requires extra concessions, even after they’ve opened up their books to the public,” says Lin. “Our findings show that post-IPO companies see the value in working with new lenders, despite the need to commit to performance-sensitive debt.”

The researchers say that performance pricing offers a low-cost way for new lenders to identify promising new public firms and build relationships, and allows flexibility to adjust terms as trust develops. For the firms, committing to performance-sensitive debt can signal confidence and help secure financing from unfamiliar lenders.

Lin collaborated on the study with Xiaoyu Zhang, PhD, assistant professor of finance in the Vrije Universiteit Amsterdam School of Business and Economics.