Institutional Stock Trading on Loan Market Information

use of personal information obtained in the credit market for public securities trading? This paper examines the institutional scholarship ….

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Growing institutional investment in the syndicated loan market was one of the defining features of the leveraged loans expansion that lasted until the second half of 2007. Although institutional participation significantly shrunk in 2008 (Ivashina and Scharfstein, 2009), many institutional investors still remain in this market and it is not unlikely that the growth of this investors’ base will become important again.
There are many interesting questions that relate to institutional participation in the credit market. In this paper we focus on one specific point: many institutional investors invest in loan market and, hence, gain access to private information about the borrower. Simultaneously, these institutions invest in public securities. In the absence of regulation, can private information about the borrower be protected from being used to trade in public markets? The evidence that we find suggests that this is not the case.
Our results indicate a causal relation between superior information and outperformance in stock trades following the release of private information about the borrower. Specifically, we collect investors’ identities from loan amendments data reported in SEC filings and follow each amendment in the news to credibly identify the timing of the public information release. We find that when a loan contract is subject to a loan amendment, institutions holding the loan of the borrower realize large positive abnormal returns in the equity market by trading in the stock of the company with the loan amendment. We further verify that this result is specific (i) to the event (loan amendment), (ii) to the institutions that have access to information released by the borrower at the loan amendment, and (iii) to the stocks of companies affected by loan amendments. Looking more broadly, we find that managers that hold stock and loans of the same company do not outperform stock investments of comparable managers that only hold stock, or that invest in stock and loans of different companies.
There is an open question: Wouldn’t borrowers want to avoid similar trading by the institutions? The likely answer is that avoidance of such trading might be not possible for the borrower. Borrowers do not directly interact with all of their lenders and lending syndicates tend to be very large. In addition, it is not clear as to which investors might use such private information to trade on or when would they do so. The cost for borrowers might be offset by the benefit of available funding

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