Lending Relationships and Information Rents: Do Banks Exploit Their Information Advantages?

Abstract

In the process of lending to a firm, a bank acquires proprietary firm-specific information that is unavailable to nonlenders. This asymmetric evolution of information between lenders and prospective lenders grants the former an information monopoly. This article empirically investigates whether relationship banks exploit this advantage by charging higher interest rates than those that would prevail were all banks symmetrically informed. My identification strategy hinges on the notion that large information shocks that level the playing field among banks erode the relationship bank's information monopoly. I use the borrower's initial public offering (IPO) as such an information-releasing event, and build a panel dataset in which the unit of observation is a firm's lending relationships before and after its IPO. Prior to a firm's IPO, I find a U-shaped relation between borrowing rates and relationship intensity. After the IPO, interest rates are decreasing in relationship intensity. Furthermore, mean interest rates drop after an IPO. The results are robust to firm and loan-year fixed effects, and to controls for firm leverage pre- and post-IPO. Thus, the reported interest rate pattern is clean of any confounding effects that might arise from changes in financial risk. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.