Why do private firms have higher cost of debt?

I like to (once in a while) repeat the analyses of prior academic publications with new and larger time-series. The idea is simple: first, I learn a lot from repeating other scholars’ work and can build on this input. Second, I can ask the question whether empirical relationships are still born out in the data, and, if not, why.

I replicated my own paper on the cost of being a private company, published in RFS in 2011 (Saunders and Steffen, 2011) and extended the dataset until 2020. The original paper and the extension focus on UK companies. In the original paper, we found a loan cost disadvantage of about 27bps and identified as mechanisms the cost of information production for private firms, relationships, private equity ownership and secondary market trading.

In my replication analysis, covering the 2010-2020 period, I confirm the loan cost disadvantage of private firms, which has even increased to about 66bps. Level spreads of loans to both public and private companies are also higher in the post-global financial crisis period.

Cost of information production is still a main driver of this loan cost differential. In other words, it appears to be hard to acquire (and verify) data on private firms which likely reduces access to credit and increases the cost of debt. A second key driver is private equity ownership.

In contrast to Saunders and Steffen (2011), loans issued by relationship borrowers are priced lower (if anything), consistent with an information specific advantage of relationship lenders. Moreover, loans that are subsequently traded have lower spreads, i.e. secondary loan prices reveal information about a firm to the investor and may lead to a reduction in the cost of debt ("information" effect).

I hope you find this interesting and please reach out if you have questions.