Credit Risk Under Common Ownership: The Benefit and Threat of Powerful Shareholders

Abstract

Existing studies show that common institutional ownership of multiple industry firms improves governance over management, because such common owners possess industry-wide information advantage and governance expertise. This paper studies whether creditors perceive common owners as allied monitors or potential powerful expropriators. I find that creditors impose less restrictive covenants on loans to firms with higher common ownership. A quasi-natural experiment using financial institution mergers suggests that the relationship is likely to be causal. This effect of common ownership is mainly pronounced in firms with more financial risk, weaker shareholder governance, and lower creditor bargaining power. Overall, these findings indicate that creditors benefit from better governance by common owners, and therefore exert less monitoring effort in firms with higher common ownership.