Essays on Financial Intermediaries

Abstract

This thesis consists of two essays on financial intermediaries. The first essay studies a causal effect of institutional ownership (IO) on bank loan pricing, using the Russell Index 1000 inclusion/exclusion as the discontinuity design setting. Specifically, I find that an exogenous positive shock in institutional ownership appears to only affect the pricing term of bank loans but not the non-pricing terms. On average, a 35 % increase in IO will lead to a 29 bps lower loan spread which is about 1/5 of the average spread. However, the non-pricing terms such as collateral, maturity, and covenants do not change with the increase in IO. The reduction in loan spread is supported by the evidence that firms with high IO will have lower credit risk measured by expected default frequency using Merton model. Also, this effect is weaker for the family firms. Further investigation reveals that increase in liquidity and direct monitoring from institutional investors could be the channels through which institutional ownership affects bank loans pricing. Moreover, although the cost of bank loan is lower for firms with higher institutional ownership, these firms do not borrow more frequently than those with lower institutional ownership.

The second essay investigates the misreporting and mis-assessment of corporate credit ratings by credit rating agencies (CRAs). We distinguish between "mis-assessment", which is the noise from the unobservable true rating to the rating perceived by CRAs (the internal rating), and "misreporting", which is the difference between perceived and reported rating by CRAs. Using a sample of corporate credit ratings during 1986-2011, we find that the mis-assessment in credit rating is very small and statistically insignificant. Also, there is a U-shaped relationship between true credit rating and misreporting probability. Specifically, CRAs misreport the credit ratings for high-grade firms with a probability of 3%, for middle-grade firms with a probability of 0, and for low-grade firms with a probability of 6%. Second, the misreporting behavior of CRAs differ significantly across the industries. The financial industry has the highest misreporting probability (35\% in the lowest-grade firms) and the largest misreporting magnitude (rating grade jump between true and reported grade). The energy industry has the lowest misreporting probability. Last, when economic conditions are bad, the credit rating agent is more likely to deflate the rating.