Bank Competition and Information Production

Abstract

We show that competition adversely affects the ''specialness'' of bank lending. In particular, we observe that the positive abnormal return on the borrowing firm's stock after the announcement of a bank loan is reduced in US states that deregulate interstate branching. The negative effect of competition on the value of bank loans is present only for ex-ante opaque firms (i.e., firms with few tangible assets and bank-dependent borrowers) and for banks that presumably rely more on ''soft'' information (i.e., small banks). Moreover, we find that the probability of a covenant violation in a syndicated deal and charge-off rates on small business loans are higher in deregulated states. Our results suggest that competition decreases loan quality because it reduces banks' incentives to invest in information.

Keywords: asymmetric information, competition, bank deregulation,syndicated loans, stock returns

JEL Classification: G21, G28