Banks’ Competitor-Specific Knowledge in Loan Markets

• In Event: Lending and Performance

Abstract

This study examines the effect of banks’ competitor-specific knowledge, whether a bank has lent money to a firm’s product-market competitors (i.e., rivals), on the matching of firms to lenders. We find an increased propensity of firms pairing up with a bank that has also lent to firms’ rivals. The relation between lending to rivals is accentuated for firms with high levels of financial reporting opacity and attenuated for firms with high proprietary costs. These cross-sectional results are consistent with the benefits of information efficiencies being greater when financial reporting opacity is higher and the costs to firms being higher when firms have greater potential proprietary information. We also examine the economic consequences of our main findings through the pricing of bank loans. Consistent with lenders being able to leverage their inside knowledge of firms within the same product market and transfer the information efficiencies to borrowers, we document a reduction in the spread over LIBOR when firms borrow from banks that have also lent to their rivals in the past five years. We further find that this reduction in interest rate to be more pronounced when the borrowers’ financial reporting quality is lower.

Authors

• Gus De Franco, University of Toronto

• Alexander Simon Edwards, University of Toronto

• Scott Liao, University of Toronto