- Financial Intermediation
- Corporate Finance
- Political Economy
Prime (Information) Brokerage
with Kevin Mullally, Sugata Ray and Yuehua Tang
Journal of Financial Economics 2020, vol. 137, 371-391
Abstract: We show that hedge funds gain an information advantage from their prime broker banks regarding the banks’ corporate borrowers. The connected hedge funds make abnormally large trades in the stocks of borrowing firms prior to loan announcements, and these trades outperform other trades. The outperformance is particularly strong for trades of hedge funds that have high revenue potential for prime broker banks. These informed trades appear to be based on information not just about the loan itself but also about firms’ fundamentals such as future earnings. Finally, we find evidence suggesting that equity analysts inside the banks are one potential conduit of information transfer.
Political Interference and Crowding Out in Bank Lending
Journal of Financial Intermediation 2020, vol. 43
Abstract: I provide novel evidence on a real cost of political interference on banks. Analyzing staggered state elections in India, I show that politically motivated increased bank lending to farmers before elections crowds out lending to manufacturing firms. These lending distortions are larger where farmers have more political weight and where incumbents have more influence over banks. Reduced bank credit forces manufacturing firms to use up cash reserves, cut production, and operate at lower factor utilization. Overall, my results suggest that preferential lending to politically important sectors can lead to costly crowding-out of real activity in other productive sectors.
The Decline of Secured Debt
with Efraim Benmelech and Raghuram Rajan
– Revise and Resubmit
– SFS Cavalcade, WFA, NBER Summer Institute
– WFA Charles River Associate Award for Best Paper on Corporate Finance
Abstract: We document a steady decline in the share of secured debt issued (as a fraction of total debt) in the United States over the twentieth century, with some pickup in this century. Superimposed on this secular trend, the share of secured debt issued is countercyclical. The secular decline in secured debt issuance seems to result from creditors acquiring greater confidence over time that the priority of their debt claims will be respected and they will be repaid without the need for security up front. Borrowers also do not seem to want to lose financial and operational flexibility by giving security up front. Instead, security is given on a contingent basis – when a firm approaches distress. Similar arguments explain why debt is more likely to be secured in the down phase of a cycle than in the up phase, thus accounting for the cyclicality of secured debt share.
Secured Credit Spreads and the Issuance of Secured Debt
with Efraim Benmelech and Raghuram Rajan
– Revise and Resubmit
– AFA 2021
Abstract: Lenders are unwilling to accept lower credit spreads for secured debt relative to unsecured debt when a firm is healthy. However, they will accept significantly lower credit spreads for secured debt when a firm’s credit quality deteriorates, the economy slows, or average credit spreads widen. This contingent valuation of collateral or security, coupled with the borrower perceiving a loss of operational and financial flexibility when issuing secured debt, may explain why firms issue secured debt on a contingent basis; they issue more when their credit quality deteriorates, the economy slows, and average credit spreads widen.
Customers as Friendly Shareholders: Uncovering the Complex Mutual Fund-Broker Relationship
with Yuehua Tang and Kelsey Wei
– WFA 2021
Abstract: This paper examines mutual funds’ dual role as both clients and shareholders of broker banks. Mutual funds are more likely to hold and significantly overweight stocks of their broker banks. Correspondingly, fund voting is biased towards broker management in contentious proposals. Such voting bias significantly affects voting outcomes but is not value-enhancing. In return, funds receive preferential IPO allocations from connected broker banks. Our study not only uncovers a new mechanism—being brokers’ friendly shareholders—through which the two parties maintain their quid pro quo relationships, it also raises a broader concern about the governance of important financial institutions.
Inter-Firm Relationships and the Special Role of Common Banks
with Emanuela Giacomini and Andy Naranjo
Abstract: Using a novel dataset that combines information on customer-supplier trade relationships with information on firm-bank lending relationships, we show that common banks that lend to firms at both ends of a trade link strengthen such trade relationships. We use bank mergers that generate exogenous variations in presence of common banks to establish causality and show that common bank relationships between customers and suppliers increase trade relationships by 41.5%. The role of common bank is greater for more opaque supply chains and when the common bank is more informed. We argue that common banks bridge information gaps between trading partners and mitigate hold-up problems. Consistent with this hypothesis, we show that firms with a higher share of trading partners with whom they also share common banks have more concentrated customer base and invest more in relationship specific assets. Lastly, we show that common banks played a central role in facilitating provision of trade credit by suppliers during the Great Recession. Overall, our findings show the unique role of banks in driving inter-firm growth.
with Sehoon Kim, Jongsub Lee and Junho Oh
Abstract: The “ESG lending” market, where loan contract terms are contingent on borrower ESG performance (i.e., ESG-linked loans), or where loans are issued for specific green projects (i.e., Green loans), has grown exponentially from $6 billion in 2016 to $173 billion in 2019. Much of this growth is driven by ESG-linked loans which are widespread across various industries and well developed capital markets, especially in civil law countries. ESG-linked loans are issued in sizeable amounts by large and publicly listed borrowers, and are often structured through revolving credit facilities by large groups of syndicates led by reputable “ESG specialist” global banks, who keep tight relationships with borrowers. Green loans are smaller project finance vehicles, similar in format to green bonds, yet issued to mostly privately held borrowers. They do not tend to attract large cross-border syndicates. We find that ESG loans tend to be written by borrowers and lenders with superior ESG profiles ex-ante, and find no evidence that their ESG performances deteriorate ex-post after ESG loan issuance. Overall, our results indicate that borrowers capable of maintaining high ESG standards and lenders capable of coordinating and monitoring ESG loan contracts drive the emergence of ESG banking activities around the globe.