Does Banks' Corporate Control Benefit Firms? Evidence from US Banks' Control Over Firms' Voting Rights

Abstract

In this paper we examine the importance of banks' corporate control by investigating the loan policy pricing effect of banks' voting stakes on their borrowers. We exploit the fact that banks may hold shares of firms in a fiduciary capacity to identify a clean measure of banks' control over firms. These shares provide no direct cash incentives to banks, but they may give them control over a stake of the firm's voting rights. Using a sample of loans taken out over the 2000-2002 time period, we document the instances where firms borrow from banks that have a trust equity investment in the firm and determine the share of the firm's voting rights that the bank controls as a result. Our investigation of loan interest rates shows that banks charge lower rates on loans to firms in which they have a voting stake, and that the interest rate discount increases with the bank's voting stake. These findings are robust to a number of firm- and loan-specific controls as well as to banks' selection of trust investments. Our investigation into the covenants of loan contracts also shows that banks are less likely to demand collateral and to impose dividend restrictions when they have control over a stake of the borrower's voting rights. These findings, together with the interest rate discount the bank offers when it holds a voting stake in the borrower, support the hypothesis that banks' corporate control over their borrowers is effective at reducing the agency costs of debt.