The Personal Touch: Interpersonal Relationships in Business Lending

李莘檑 | KHAN, Urooj | WILLIAMS, Christopher | WITTENBERG-MOERMAN, Regina

When a business borrows money, its information asymmetry and the associated agency problems and its perceived ability to repay the debt are crucial considerations for lenders. However, these are not the only factors at play. HKUST’s Xinlei Li and co-authors shed light on the importance of personal relationships in mitigating agency problems of the lending process, and whether these connections endure when an executive moves to another firm. 

Previous research on commercial lending has focused on relationships between institutions, paying little attention to interpersonal connections between senior managers (such as CEOs and CFOs) and lenders. However, the major challenge to examine personal lending relationships is that it’s difficult to disentangle the manager effect from the firm effect.  To overcome this challenge, the authors devised a novel approach to explore the managerial turnover setting and study whether lenders and the manager continue to benefit from their relationships after the turnover

Using a sample of 1,994 cases in which a senior executive leaves one business and joins another, the researchers find conclusive evidence that the lending relationship continues into the executive’s new role. This is known as co-migration. “A lender is 1.6 times more likely to start a lending relationship with a firm,” the researchers report, “when a manager with whom it has had a lending relationship moves to the firm as a senior executive.”  

Previous history and existing lines of communication are factors in maintaining ties through a move, but the authors believe that the connection goes even deeper. “A lender that has developed a stronger relationship with the manager at the origin firm,” they explain, “is also likely to have deeper insights about her talent, motivation, risk-tolerance and strategic vision.”

How durable is the relationship between lenders and senior executives? To put this to the test, the researchers examine the influence of the information and accounting environments of borrowing firms. In a more opaque information environment, lenders rely more heavily on personal relationships with managers, which give them a better understanding of the workings of the borrowing firms. This increases the likelihood of co-migration. “When a lender can monitor the destination firm more efficiently,” say the authors, “it is more likely to initiate a relationship with it following the manager’s move.”

However, the researchers observe an interesting situation where personal lending relationships can fail: lenders are less likely to follow managers if the companies that they are leaving or joining have experienced accounting irregularities. Such irregularities damage the reputations of both firms and managers. In these cases, the authors explain, “even lenders with strong monitoring capabilities are mostly reluctant to continue their relationship with a migrating manager.”

This novel study provides a rich basis for future studies on the “personal touch” in commercial lending, but what are the practical takeaways for borrowing and lending firms? Existing relationships can bring significant financial benefits for executives, their new firms, and lenders alike—especially in an opaque environment. “Because opaque borrowers rely primarily on relationship lending and obtain relatively lenient contractual terms when borrowing from relationship lenders,” state the researchers, “a manager is likely to seek financing from lenders with whom she has personal relationships.”

Lenders also benefit from the privileged insights offered by such interpersonal connections. “Greater monitoring efficiency is likely to enhance lenders’ competitive advantage,” the researchers tell us. However, their findings also “underscore the significant negative implications of hiring an executive associated with accounting irregularities, as doing so is likely to hurt a firm’s borrowing capabilities.”


Assistant Professor