American companies are now borrowing billions of dollars behind closed doors, hiding from view. Private lending firms supply the money, allowing companies to cut deals out of regulators’ sight.
According to Jared A. Ellias of Harvard Law School and Elisabeth de Fontenay of Duke University School of Law, this trend could leave the public with little information about many U.S. companies.
For much of the 20th century, companies borrowed from a single bank, which closely watched the company’s finances and behavior. However, in the 1980s, banks began splitting giant loans into pieces and selling them to large investors.
This shift made information more visible, as borrowers had to share more about their finances, and loan prices served as an early warning when a company was in trouble. Ellias and de Fontenay argue that these visible price signals helped steer money toward stronger businesses and away from weaker ones.
Private Credit Firms Rise
Recently, the pattern has flipped again, with private credit firms financing many deals. Ellias and de Fontenay posit that, as a result, almost no one outside the deal sees the transaction.
Both borrowers and lenders favor this setup, as it makes the process faster, quieter, and more flexible. Private credit firms can charge high interest rates and negotiate terms that favor them, in part because competition is thinner.
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Unlike banks, private credit firms do not face the same layers of regulation, which lowers costs and lets them move faster. However, this model makes already-scarce information even scarcer, as many companies have private owners and do not share basic facts about ownership and performance in routine reports required of public companies. Even so, Ellias and de Fontenay note that, when investors buy and sell these company loans, outsiders could still learn from the price: If the loan price moves up or down, it hints at trouble or improvement, even when ownership is private.
With the rise of private credit firms, Ellias and de Fontenay posit that the public may have little or no information at all about many or most U.S. companies—a segment of the U.S. economy may simply “go dark.”
Consequences of Information Gap
Ellias and de Fontenay warn that consequences may follow the widened information gap. For instance, they explain that estimates of how much a company is worth can drift far from reality when few people outside corporate deals can see reliable information. In addition, they posit that with less information comes less scrutiny and enforcement, which makes fraud and dishonesty more likely.
Ellias and de Fontenay also argue that the lack of information could lead to market distortions, money sticking with weak companies when stronger ones go underfunded, and could trigger sharp price swings when reality catches up, hitting Wall Street and retirement accounts alike.
Although Ellias and de Fontenay focus on identifying risks, they propose first steps toward a solution. If the market fails to police deals between private credit firms and companies, they argue, then bankruptcy judges must do it when a company fails. They warn that judges should stop assuming the market has already found the correct price. Instead, they urge judges to turn the lights on: demand full information, slow things down when needed, test the price and the financing, and stop any rushed deal that lets one private lending firm force through a solution without a real check.