RFS Advance Access published online on September 24, 2009
Review of Financial Studies, doi:10.1093/rfs/hhp074
The Impact of a Strong Bank-Firm Relationship on the Borrowing Firm
College of Management, Georgia Institute of Technology
INSEAD, France
Send correspondence to either author: Nishant Dass, College of Management, Georgia Institute of Technology, 800 W. Peachtree St. NW, Atlanta, GA 30308; telephone: 404-894-5109; fax: 1-404-894-6030. E-mail: nishant.dass{at}mgt.gatech.edu. Massimo Massa, Finance Department, INSEAD, Boulevard de Constance, 77305 Fontainebleau, France; telephone: +33-1-6072-4481; fax: +33-1-6072-4045. E-mail: massimo.massa{at}insead.edu.
JEL Classification: G10, G21, G30, G34
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Abstract |
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Commercial banks acquire inside information about the firms they lend to. We study the impact of this informationally privileged position on the borrowing firm using a broad panel of U.S. firms over the 1993–2004 period. We measure the strength of the bank-firm relationship by bank-firm proximity, size of the loan, and the lender's insider potential. We show that a stronger relationship, by inducing better monitoring, improves the borrower's corporate governance. Simultaneously, it makes the bank a potentially more informed agent in the equity market. This information asymmetry increases adverse selection for the other market participants and lowers the firm's stock liquidity. This trade-off between improved corporate governance and greater information asymmetry affects the firm's value. Our results have normative implications for the role of banks in the development of financial markets.
This article was circulated under the title "The Bank-Firm Relationship: A Trade-Off between Better Governance and Greater Information Asymmetry," and before that as "The Dark Side of Bank-Firm Relationship: The Market Liquidity Impact of Bank Lending." We have benefited from the comments of Viral Acharya, Malcolm Baker, Sreedhar Bharath, Jean Dermine, Mariassunta Giannetti, Denis Gromb, Roman Inderst, Kose John, Ron Masulis, Michael Roberts, Erik Stafford, Jeremy Stein, Amir Sufi, and especially Paolo Fulghieri (the editor) and two anonymous referees. Comments of seminar participants and our discussants—Mark Flannery, Leora Klapper, Adriano Rampini, and Carola Schenone—at the NYU/NYFed, JFI/World Bank, RFS/Wharton/NYFed, and Wash U. (Olin) conferences, respectively, as well as seminar participants at the Atlanta Fed's 2007 All-Georgia Conference were also extremely useful. We thank Anantha M. Ranganathan and William Fisk for their invaluable help with the name-recognition algorithm. All errors are our own.