Extensive prior research suggests that the announcement of a loan agreement produces positive abnormal returns for the borrowing firm. The specialization, monitoring, screening, and certification functions associated with lending relationships may contribute to these positive abnormal returns. The informational benefits that are associated with relationship banking, and that underlay the positive abnormal returns, presumably exceed any “holdup” costs potentially associated with relationship banking (Boot (2000). These positive abnormal returns may also stem from the contractual flexibility of bank lending that supplements the monitoring function performed by the lender (Preece and Mullineaux, 1996).
In recent years, however, there has been increasing evidence and discussion of the changing nature of bank intermediation and the value of bank relationships. Boot (2000) points out that the proliferation of direct funding available to firms in the financial markets has started to “seriously challenge banks’ future as relationship bankers.” When investment banks underwrite public issues, they encounter credit risk and the risk involved in placing the securities, moving their role much closer to that of a traditional bank involved in lending and placing syndicated loans. A recent article in the financial press described how banks are acting less like lenders and more like middle-men between borrowers and investors, i.e., the banks are acting more like bond markets. These trends suggest that the traditional market reaction to news of a bank loan may also have changed. Virtually all of the research in the extensive literature on loan announcements uses samples that include the 1970s, 1980s, and in a few cases the early 1990s. By combining the earlier sample periods with more recent data, our paper seeks to determine how the well-established loan announcement reaction has survived the changes in traditional bank lending relationships.
Empirical evidence by James (1987) and by Lummer and McConnell (1989) show positive and significant abnormal returns associated with loan announcements. While James does not distinguish between new loans and renewals, Lummer and McConnell find that positive abnormal returns are limited to renewals. They report that announcement period returns for new loans are statistically insignificant. Abnormal returns in prior studies appear to be associated with the quality of the lender (Billett, Flannery, and Garfinkel (1998), the size of the borrower (Slovin, Johnson, and Glascock (1992), the creditworthiness of the borrower (Best and Zhang (1993), the nature of the lender (Byers, Fraser, and Shockley (1998), and the syndication characteristics of the loan agreement (Megginson, Poulson, and Sinkey (1993) and Preece and Mullineaux (1996). Billett, Flannery, and Garfinkel (2001) also show that, although loan announcement returns are generally positive, borrowers significantly underperform over the three years following the announcement.
To the extent that the positive abnormal returns from loan announcements stem from unique characteristics associated with relationship banking, recent changes in the structure of the banking and financial system may have eroded these benefits. As Boot (2000) points out, relationship banking has two critical dimensions: 1) the production by a financial intermediary of customer specific information, generally proprietary, and 2) the existence of multiple interactions with the same customer over time and/or products.
These characteristics describe a bank centered financial system rather than a market centered financial system. Yet the role of commercial banks and other financial intermediaries in the lending process has diminished greatly.
James and Smith (2000) point out that the share of bank credit in the financing of U. S. corporations has diminished substantially. Corporations increasingly depend upon financial markets rather than financial intermediaries for their financial needs. For example, the Federal Reserve’s Flow of Funds Accounts report that non farm non financial corporate business used market sources (commercial paper and corporate bonds) for funding in 1980 in amounts roughly equal to their use of bank credit. By the year 2000, however, the credit markets provided roughly $5 to non farm non financial corporate businesses for every $1 provided by commercial banks. These structural changes in the financial system raise questions about the durability of these positive abnormal loan announcement returns.
