Intermediary Frictions and the Corporate Credit Cycle: Evidence from CLOs

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I quantify the contribution of intermediary agency frictions to the cyclicality of lending by collateralized loan obligations (CLOs). CLOs’ cost of debt contains significant compensation for agency problems arising from CLOs’ discretion in trading. Agency problems intensify in volatile periods, raising CLOs’ cost of debt, reducing the issuance of new CLOs, and affecting real outcomes in CLO-dependent firms. To mitigate this effect, CLOs issued in volatile periods restrict their discretion, which, however, also limits valuable trading. Using a structural model, I estimate that one third of the steep fall in CLO issuance during volatile periods is due to agency frictions.
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