The “Dominant Bank Effect:” How High Lender Reputation Affects the Information Content and Terms of Bank Loans

Abstract

Three large banks control over half of the U.S. commercial loan market by volume through the syndication process. Using attributes of a borrower’s location to instrument for lender– borrower matching, I show that the borrower stock price response to a loan announcement is more favorable if one of these dominant banks is the lender, especially if the borrower is “opaque. ” I then show that these banks charge lower interest rates and are more likely to lend without the protection of a borrowing base. The results suggest that the domi-nant banks have a particularly high reputation for screening and monitoring borrowers. (JEL G21, L14) In financial economics, it has long been recognized that commercial banks play a special certification role through inside lending (Fama 1985) and delegated monitoring (Diamond 1984). It therefore follows that bank loan announce-ments should convey a positive signal or certification to the market that the borrower is “good.”1 In that regard, Mikkelson and Partch (1986) and James (1987) document that bank loan announcements elicit positive abnormal re-turns in borrower stocks, whereas announcements of public securities issues