Sustainability of Direct Lending: Evidence from Index Exclusion

Abstract

The 2006 change in the disclosure requirements for Acquired Fund Fees and Expenses (AFFE) led to the exclusion of business development companies (BDCs) from major stock indexes in 2014, constituting a contractionary shock to the flow of equity capital into publicly traded BDCs. In a difference-in-differences setting, we demonstrate that AFFEcted BDCs — those with high pre-shock mutual fund ownership — experience a 10%-14% larger drop in their equity growth and 12%-16% larger decline in investment growth relative to non-AFFEcted BDCs. These findings highlight the importance of access to capital markets for BDCs to sustain their investment activities. Exploiting the geographic dispersion of BDC borrowers, we further document the negative impact of the AFFE regulation on local employment growth.