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Hidden Gems and Borrowers with Dirty Little Secrets: Investment in Soft Information, Borrower Self-Selection and Competition

European Banking Center Discussion Paper No. 2013-005

CentER Discussion Paper Series No. 2013-027

54 Pages Posted: 11 May 2012 Last revised: 5 Nov 2017

Reint Gropp

Halle Institute for Economic Research

Christian Gruendl

EBS Universität für Wirtschaft und Recht

Andre Guettler

University of Ulm - Department of Mathematics and Economics; Halle Institute for Economic Research

Date Written: May 8, 2013

Abstract

This paper empirically examines the role of soft information in the competitive interaction between relationship and transaction banks. Soft information can be interpreted as a private signal about the quality of a firm that is observable to a relationship bank, but not to a transaction bank. We show that borrowers self-select to relationship banks depending on whether their privately observed soft information is positive or negative. Competition affects the investment in learning the private signal from firms by relationship banks and transaction banks asymmetrically. Relationship banks invest more; transaction banks invest less in soft information, exacerbating the selection effect. Finally, we show that firms where soft information was important in the lending decision were no more likely to default compared to firms where only financial information was used.

Keywords: soft information, discretionary lending, relationship bank, bank risk

JEL Classification: G21, G28, G32

Suggested Citation

Gropp, Reint and Gruendl, Christian and Guettler, Andre, Hidden Gems and Borrowers with Dirty Little Secrets: Investment in Soft Information, Borrower Self-Selection and Competition (May 8, 2013). CentER Discussion Paper Series No. 2013-027. Available at SSRN: https://ssrn.com/abstract=2033655 or http://dx.doi.org/10.2139/ssrn.2033655

Reint Gropp (Contact Author)

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

Christian Gruendl

EBS Universität für Wirtschaft und Recht ( email )

Wiesbaden, Hessen 65189
Germany

Andre Guettler

University of Ulm - Department of Mathematics and Economics ( email )

Helmholzstrasse
Ulm, D-89081
Germany

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

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