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Throwing Good Money after Bad? Board Connections and Conflicts in Bank Lending

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  • Randall S. Kroszner
  • Philip E. Strahan

Abstract

This paper investigates the frequency of connections between banks and non-financial firms through board linkages and whether those connections affect lending and borrowing behavior. Although a board linkages may reduce the costs of information flows between the lender and borrower, a board linkage may generate pressure for special treatment of a borrower not normally justifiable on economic grounds. To address this issue, we first document that banks are heavily involved in the corporate governance network through frequent board linkages. Banks tend to have larger boards with a higher proportion of outside directors than non-financial firms, and bank officer-directors tend to have more external board directorships than executives of non-financial firms. We then show that low-information cost firms – large firms with a high proportion of tangible assets and relatively stable stock returns -- are most likely to have board connections to banks. These same low-information cost firms are also more likely to borrow from their connected bank, and when they do so the terms of the loan appear similar to loans to unconnected firms. In contrast to studies of Mexico, Russia and Asia where connections have been misused, our results suggest that avoidance of potential conflicts of interest explains both the allocation and behavior of bankers in the U.S. corporate governance system.

Suggested Citation

  • Randall S. Kroszner & Philip E. Strahan, 2001. "Throwing Good Money after Bad? Board Connections and Conflicts in Bank Lending," Center for Financial Institutions Working Papers 02-12, Wharton School Center for Financial Institutions, University of Pennsylvania.
  • Handle: RePEc:wop:pennin:02-12
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    File URL: http://fic.wharton.upenn.edu/fic/papers/02/0212.pdf
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    References listed on IDEAS

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    Cited by:

    1. Joel Houston & Jennifer Itzkowitz & Andy Naranjo, 2012. "Corporate Borrower Nationality and Global Presence: Cross-Country Evidence on the Pricing of Syndicated Bank Loans," Chapters,in: Research Handbook on International Banking and Governance, chapter 5 Edward Elgar Publishing.
    2. Houston, Joel F. & Itzkowitz, Jennifer & Naranjo, Andy, 2017. "Borrowing beyond borders: Foreign assets, lender choice, and loan pricing in the syndicated bank loan market," Journal of Corporate Finance, Elsevier, vol. 42(C), pages 315-334.
    3. Al-Jarhi, Mabid Ali, 2005. "The Case For Universal Banking As A Component Of Islamic Banking," Islamic Economic Studies, The Islamic Research and Training Institute (IRTI), vol. 13, pages 2-65.
    4. Giglio, Ricardo & Lux, Thomas, 2016. "The core of the global corporate network," FinMaP-Working Papers 59, Collaborative EU Project FinMaP - Financial Distortions and Macroeconomic Performance: Expectations, Constraints and Interaction of Agents.

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