Stock price fragility and the cost of bank loans

Abstract

This study examines whether the flow volatility experienced by institutional investors affects firms’ financing costs. Using Greenwood and Thesmar’s (2011) stock price fragility measure, we find that there is a positive relationship between fragility and firms’ costs of bank loans. This effect is most pronounced when lenders rely more on institutional shareholders to discipline corporate management, or when loans are made by relationship lenders, suggesting that unstable flows could weaken institutional investors’ monitoring effectiveness and strengthen relationship banks’ bargaining power. • Flow volatility experienced by institutional investors affects firms’ financing costs. • Unstable flows affect financing costs by weakening institutional investors’ monitoring effectiveness and strengthening relationship banks’ bargaining power. • Flow volatility also impacts other aspects of the loan contract, such as loan maturity, use of collateral, and use of covenants. • The paper adds to the evidence that non-fundamental risks (institutional investors’ flow shocks) can have a real impact on firms.