- 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
– 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.
Institution-Broker Relationship and Mutual Fund Proxy Voting
with Yuehua Tang and Kelsey Wei
– WFA 2021
Abstract: We show that mutual funds are more likely to hold and significantly overweight stocks of investment banks with which they have brokerage business ties. In line with the portfolio decisions, mutual fund proxy voting is biased towards the management of connected brokers in contentious proposals. Larger portfolio overweighting by client funds is associated with a stronger voting bias towards the brokers’ management. In return, mutual funds with greater portfolio overweighting and voting bias receive larger allocations of underpriced IPOs from connected brokers serving as lead underwriters. Overall, our study not only uncovers a new mechanism—being brokers’ friendly shareholders—through which mutual funds and investment banks maintain their quid pro quo relationships, it also raises a broader concern on shareholder monitoring of large, systemically 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.