Essays on Financial Frictions in Lending Markets Daetz, Stine Louise Document Version Final published version Publication date: 2018 License CC BY-NC-ND Citation for published version (APA): Daetz, S. L. (2018). Essays on Financial Frictions in Lending Markets. PhD series No. 31.2018 Link to publication in CBS Research Portal General rights Copyright and moral rights for the publications made accessible in the public portal are retained by the authors and/or other copyright owners and it is a condition of accessing publications that users recognise and abide by the legal requirements associated with these rights. Take down policy If you believe that this document breaches copyright please contact us ([email protected]) providing details, and we will remove access to the work immediately and investigate your claim. Download date: 23. Sep. 2021 COPENHAGEN BUSINESS SCHOOL ON FINANCIAL FRICTIONS IN LENDING MARKETS ESSAYS SOLBJERG PLADS 3 DK-2000 FREDERIKSBERG DANMARK WWW.CBS.DK ISSN 0906-6934 Print ISBN: 978-87-93744-08-0 Online ISBN: 978-87-93744-09-7 Stine Louise Daetz ESSAYS ON FINANCIAL FRICTIONS IN LENDING MARKETS Ph.D. School in Economics and Management PhD Series 31.2018 PhD Series 31-2018 Essays on Financial Frictions in Lending Markets Stine Louise Daetz Supervisor: Jens Dick-Nielsen Ph.D. School in Economics and Management Copenhagen Business School Stine Louise Daetz Essays on Financial Frictions in Lending Markets 1st edition 2018 PhD Series 31.2018 Print ISBN: 978-87-93 744-0 8 -0 Online ISBN: 978-87-93744-09-7 © Stine Louise Daetz ISSN 0906-6934 The PhD School in Economics and Management is an active national and international research environment at CBS for research degree students who deal with economics and management at business, industry and country level in a theoretical and empirical manner. All rights reserved. No parts of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage or retrieval system, without permission in writing from the publisher. Preface This thesis includes three essays that I worked on during my Ph.D. studies at the Copen- hagen Business School, Department of Finance. While the articles overlap in the aim of understanding financial frictions in lending markets, they are self-contained and can be read independently. This thesis has benefited from the advice, helpful comments and support of many people. First of all, I would like to thank my advisors at CBS, Jens Dick-Nielsen and David Lando, for their tremendously help, support and advice at any point in time. Their guidance contributed significantly to my academic development and also helped me to tackle the academic job market. In particular, I am grateful to Jens Dick-Nielsen's continuous encouragement and availability to give advises. I would also like to thank David Lando's for his general mentorship and to take this opportunity to also gratefully acknowledge the financial support of the FRIC Center for Financial Frictions (grant no. DNRF102). I am further thankful to Marti G. Subrahmanyam for hosting my visits at NYU Stern, his mentorship through our joint research work, as well as his general support during my final years of the Ph.D. studies. In addition, I would like to thank my co-authors, Dragon Y. Tang, Sarah Q. Wang and Mads S. Nielsen for their patience, support, and our great discussions that provided me with significant learning experiences. Finally, I would also like to thank my colleagues and friends for their support. In particular, I would like to thank the faculty at CBS and my fellow Ph.D. students for their patience, valuable feedback and helpful discussions, as well as for making my years as a Ph.D. student enjoyable and instructive. Most importantly, I am thankful for the invaluable support and love of Rasmus, my family, and friends, and their unwavering believe in me. Stine Louise Daetz Frederiksberg, June 2018 ii Summary in English Essay 1: The Value of Bond Underwriter Relationships with Jens Dick-Nielsen and Mads Stenbo Nielsen The first essay shows that corporate bond issuers derive value from bond underwriter relationship capital. A strong underwriter relationship enables the underwriter to credibly certify the issuer on the bond market which is fundamental for firms when issuing new debt and refinancing maturing debt. In order to empirically verify this certification hypothesis we study corporate bond issuing firms’ underwriter relations and analyze their value for the issuing firm. First, we look at the unconditional effect of switching underwriter and empirically test the benefit of having a strong underwriter relationship by analyzing firms’ underwriter relations and bond issuance cost. Within this framework we find that when a bond issuer utilizes an existing underwriter relationship when rolling over bonds, it lowers both the indirect and direct issuance costs. Accordingly, it is as a baseline costly for the firm to switch underwriter. Second, we document that issuers are adversely affected by underwriter distress as we find that the credit risk of the underwriter spills over to the credit risk of the issuer. If an underwriter ends up in financial distress it weakens the underwriter's ability to connect the bond issuer with investors and to credibly certify the issuer. As this is costly for the bond issuer when rolling over maturing bonds, we argue that the weakened relationship leads to higher credit risk of the issuing firm. By constructing an issuer specific measure of underwriter distress we explicitly find that the variation in the credit risk of related underwriters helps explain the variation in the credit risk of bond issuers. While we do find that the effect is pronounced in the case of an actual default of an underwriter that will force firms to switch underwriter, we document that the effect is also economically significant for just higher level of underwriter distress. Consistent with the certification hypothesis we find that the credit risk spillover is more pronounced for low-rated firms which are usually also more opaque and, therefore, more dependent upon the underwriter certification. The impact of underwriter distress is also stronger for firms with a high fraction of short-term debt, i.e., firms with an imminent need for underwriter services for rolling over maturing bonds. Thus, underwriter distress can be characterized as a rollover risk for the issuer. Overall, the essay shows that underwriter relationships are valuable for corporate bond issuers. iii Essay 2: Corporate Hedging and Debt Extension The second essay provides a detailed investigation of the implications of creditors' use of credit default swaps (CDSs) for the debt financing of related firms. CDSs are financial derivatives that protect the buyer against default of a given reference firm. The availabil- ity of CDS contracts has in general been outlined to improve bank lending by reducing financial frictions on the supply side of credit. Using unique and comprehensive CDS and credit registry data from Deutsche Bundesbank I explicitly study the CDS holdings of banks with a credit relationship to the reference firm and analyze the role of the varia- tion in creditors use of CDSs for the borrower's debt financing. As outlined in the data creditors typically hold multiple CDSs written on the same firm and are often also net sellers of CDS contracts written on their own borrowers. Focusing on firm-level credit exposures I find that the credit extension arising due to the availability of CDSs significantly depends upon creditors' net CDS positions. Specifi- cally, I find that firms where the creditors are net credit protection buyers have relatively less credit available relative to firms where the creditors are net credit protection sellers. Although individual creditors may extend their credit exposure to firms for certain levels of credit hedging, I find that the effect is not significant on the aggregated level. This is probably due to the offset effect by the firm’s other creditors. While creditors typically buy CDS contracts on more risky borrowers, I also show that the results are robust when I explicitly control for firms’ credit risk. Furthermore, the effect is pronounced when CDS contracts are illiquid. In regards to firms’ refinancing risk, I find that firms with net CDS-buying creditors relative to firms with net CDS-selling creditors have lower debt maturity and are more constrained with respect to the type of debt they can issue when they refinance their maturing debt. However, I do not find that the direct debt financing costs these firms are higher. Accordingly, the results suggest that the change in firms’ refinancing conditions are caused by creditors' aim for lower monitoring costs that is supplementary to the decrease in credit risk stemming from their credit hedging. Although firms with available CDS contracts still have lower rollover risk compared to firms for whom CDS contracts are not available, the essay provides evidence that the CDS positions of creditors may imply an indirect cost to firms in form of credit rationing. iv Essay 3: Can Central Banks Boost Corporate Investment: Evidence from ECB's Liquidity Injections with Marti G. Subrahmanyam, Dragon Y. Tang, and Sarah Q. Wang The third essay investigates whether unconventional monetary interventions by cen- tral banks can stimulate corporate investment and, thus, affect the real economy. Specif- ically, we address this question by analyzing ECB's three-year Longer-term Refinancing Operations (LTROs) as of 2011-2012. The LTROs were large liquidity injections that were implemented to support the real economic recovery after the European Sovereign Debt Crisis and provided cheap funding to Eurozone banks. For the empirical investi- gation of the impact of such liquidity interventions, we make use of comprehensive data on banks' use of the LTRO funds and Eurozone non-financial corporations' investment policies around the LTRO implementation.