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Research
Dec 1, 2017

The Value of Lending to Bellwether Firms by Institutional Investors

Abstract

This study provides evidence that nonbank institutional investors that participate in loan syndicates value inside information obtained through lending agreements with bellwether borrowers. The private information nonbank institutional investors obtain from lending relationships with bellwether firms can help identify trading opportunities in other public market securities. Thus, we predict and find that institutional investors compensate bellwether firms by charging a lower loan spread. To mitigate the potential for alternative explanations for non-bank institutional lenders charging a lower loan spread to bellwether borrowers, we conduct several additional tests to determine whether the loan spread effect is stronger when the value of inside information from bellwether firms is likely to be higher: during periods of high market uncertainty, in the period after the enactment of Regulation Fair Disclosure (Reg FD) by the Securities and Exchange Commission, for loans with a high number of financial covenants, and for loans granted to firms with less transparent information environments. We find evidence consistent with each of these predictions. We also predict and find evidence that institutional investors use private information acquired during lending relationships with bellwether borrowers to trade in public securities. In particular, we find that in the quarter during which institutional investors lend to bellwether firms, they earn excess returns of 70 bps relative to institutional investors that do not lend to bellwether firms, and excess returns of 60 bps relative to quarters in which they do not lend to bellwether firms. Such returns translate to annualized incremental returns of approximately 2.4-2.8% for institutional lenders that lend to bellwether borrowers.


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