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1. Introduction
The banks’ informational hold-up effects are one of the key issues in corporate finance. Hold-up costs tighten a firm’s cash flows and cause underinvestment.
According to Rajan’s (1992) theoretical model, inside banks have informational
advantages and bid on loans to a firm only when they know the firm will succeed.
Conversely, outside banks have no access to the firm’s private information and encounter the “winner’s curse” problem: That is, they are more likely to win a loan
when the firm has a high chance of failure. When a borrower’s credit risk increases to the point of being labeled a “lemon,” the probability that outside banks bid on the loan
declines, which allows inside banks to hold-up the borrower. Rajan suggests that bank
debts increase monitoring of borrowers; however, the monitoring process can provide inside banks with a monopoly control on information about borrowers’ creditworthiness.
If borrowing firms fail to disclose their private information, information asymmetries between borrowing firms and outside banks occur. A high level of information asymmetry results in a low probability that outside banks bid on loans to borrowers. As
a result, inside banks can hold up borrowers to extract higher interest. The inference of Rajan’s model leads to an important empirical question: How can borrowing firms limit
the monopoly power of the inside banks and thereby mitigate the hold-up problem?
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Earlier studies focus on the decision to switch from a single bank relationship to multiple bank relationships. For example, Houston and James (1996) examine the determinants for the mix of public and private debt for a sample of U.S. firms. Using a sample of Portuguese private firms, Farinha and Santos (2002) investigate the likelihood that firms substitute a single bank relation with multiple bank relationships.
Both studies find that bank-dependent firms with more growth opportunities and poor liquidity are more likely to switch from a single bank relationship to multiple bank relationships to reduce the hold-up costs.
Many recent empirical studies examine whether revealing a firm’s private information to the public can reduce inside banks’ hold-up power. Santos and Winton
(2008) find that U.S. firms that have most recently issued public bonds prior to a loan origination pay lower interest on bank loans than firms that have no access to public bond markets. Hale and Santos (2009) report that firms pay lower interest rates on bank loans after a bond initial public offering (IPO). These findings suggest that when a firm issues public bonds, it reveals its creditworthiness to the public.1 The disclosure of information reduces information asymmetry between outside banks and borrowers.
1 Hale and Santos (2009) find that a majority of firms with bond IPOs have the first rating from rating agencies. Also, Liu and Thakor (1984), Ederington, Yawitz, and Roberts (1987), and Hand, Hothausen and Leftwich (1992) report informational spill-over effects of bond ratings.
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Therefore, the probability that an outside bank bids on loans to the firm increases, thus diminishing the hold-up power of inside banks.
Issuing public bonds is not the only way for firms to disclose private information.
Schenone (2010) investigates the pattern of loan interest rates before and after an equity IPO for U.S. firms and finds that information released through equity IPOs spill overs to outside banks. Thus, competition increases among banks, which mitigates the hold-up effects. Pagano, Panetta, and Zingales (1998) report a similar result. They analyze a sample of Italian firms and find that these firms’ cost of debt declines after their equity IPOs. In addition, Saunders and Steffen (2011) find that the delisting of British firms shifts the bargaining power from borrowers to lenders and increases the information production cost.
In sum, prior studies suggest that firms’ disclosure of private information to the public significantly reduce lenders’ ability to hold up borrowers. Santos and Winton
(2008) and Hale and Santos (2009) provide evidence of hold-up costs, measured by the difference in loan spreads paid by bank-dependent and nonbank-dependent firms.
However, most prior empirical research on hold-up costs relates to the United States or a single country (e.g., Mattes,
Sascba, and Wahrenburg, 2013). However, banks in
different countries do not operate in the same economic and legal environments. Thus,‧ 國
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the question remains: Are hold-up costs a global phenomenon with significant cost
variation across countries? If so, what factors cause the discrepancies? To address these questions, we apply Santos and Winton’s methodology to an international sample to
examine various issues related to hold-up effects. To the best of our knowledge, this study is the first to provide an international comparison of hold-up effects.
Using indices of bank regulatory and supervision policies compiled by Barth, Caprio, and Lavine (2004, 2006, 2008, 2013), we hypothesize that bank regulations help to explain cross-country variation in hold-up effects. We also examine the relation between business cycles and hold-up effects. Santos and Winton (2008) find that in the U.S., hold-up effects are significant during recessions but not expansions. We examine if this relation holds for an international sample. In addition, we investigate whether hold-up effects occur during banking and financial crises. Banking crises, characterized by a liquidity crunch and increasing uncertainty, reflect the financial distress of lending banks. Therefore, we investigate whether banking crises affect the hold-up power of inside banks. Santos and Winton use recessions to capture the credit risk and uncertainty of borrowers. One consequence of the 2007–2008 financial crisis was a loss of confidence in credit rating agencies. For example, Bedendo, Cathcart, El-Jahel, and Evans (2013) provide evidence that the reputational damage of credit rating agencies
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in rating structured products spilled over to corporate bond rating services. If the
informational value of public debt diminishes, information asymmetry between outside banks and borrowers increases, thus increasing inside banks’ ability to hold up
borrowers. We measure the impact of banking crisis and the 2008–2009 crisis by examining the difference in loan spreads between bank-dependent (i.e., firms that do not have public bonds prior to the loan origination) and nonbank-dependent firms (i.e., firms that issued public bonds prior to the loan origination).
We divide our sample between U.S. firms and non-U.S. firms and find that significant hold-up effects exist for both subsamples, with a higher effect for U.S. firms.
Specifically, the average loan spread of U.S. firms (non-U.S. firms) that recently issued public bonds is 92.4 (42.9) basis points lower than those without public bonds. In other words, average hold-up costs in the United States are more than twice of those for non-U.S. firms.
Our regression results show that bank regulations significantly affect hold-up effects. In countries with more stringent bank regulations, firms without public bonds pay higher interest rates on bank loans than those with public bonds. The results are robust to controlling for firm and loan characteristics as well as the possible endogeneity of access to public bond markets. These results show that inside banks in
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countries with stringent regulations are more likely to exploit their monopoly power to capture higher informational rents and thus transfer regulatory costs to borrowers.
Like Santos and Winton (2008), we find significant hold-up effects during recessions. However, we find no significant difference in loan spreads between
bank-dependent and nonbank-bank-dependent firms during banking crises and the 2007–2008 financial crisis. In fact, inside banks’ hold-up power declines during banking crises. The
absence of significant hold-up effects during the 2007–2008 financial crisis can be
attributed to the credit rating crisis, which reduces the informational value of public bonds. Moreover, when more firms’ bonds are nonrated or have a below-investment
grade, the informational advantage of public bonds declines. As a result, access to public bond markets no longer leads to lower loan spreads.
The remainder of this paper is organized as follows. Section 2 describes the data and methodology and presents the summary statistics of all variables. Section 3 discusses the hypotheses and empirical models. Section 4 presents the main empirical results, and Section 5 provides the results of robustness tests. Finally, Section 6 concludes.