Lenders’ Environmental Monitoring: Evidence from Environmental Covenants in Private Loan Contracts

• In Event: Doctoral Student Faculty Interchange IV

Abstract

Little is known about whether and how private lenders monitor borrowers’ environmental conduct. To shed light on this question, we utilize a machine learning algorithm to identify environmental covenants in loan contracts. Consistent with contracting theory, the use of environmental covenants is systematically associated with lenders’ monitoring demand. This relation is more pronounced when the risk of financial distress and the risk of regulatory enforcement is high. Additional analysis suggests that monitoring reduces borrowers’ environmental risk-taking incentives. This study provides the first large-sample evidence of lenders’ environmental monitoring, indicating that the private sector can play an important role in addressing the problem of environmental externalities.

Authors

• Ruby Lee, University of Florida

• Mark Zakota, University of Florida