The impact of laws and institutions on financial contracts: Evidence from relationship lending across the world

Using loan data from public firms from 40 countries, we examine the association between lending relationships and loan contract terms. We find significant variation across countries regarding the benefits and costs of banking relationships, which can be explained by the countries’ differential legal and regulatory environments. In countries with weak disclosure regulations and institutions, borrowers pay significantly higher interest rates on relationship loans. However, as countries’ disclosure regulations improve, the gap in the interest cost between relationship and transactional loans is reduced. In further corroboration of this effect, we document an improvement in the relative costs of relationship lending following a country's IFRS adoption.