Bank Competition and Firms' Risk-Taking

Abstract

Research shows that bank competition affects general economic and banking-related outcomes, but much less is known about how it impacts firms' risk-taking. By exploiting staggered regulatory reforms across different U.S. states,  we show that  bank competition significantly reduces borrowers' risk-taking.  In response to bank competition,  firms invest in more capital-intensive but less risky projects: they increase capital expenditures and maintain stable R&D expenses, while reducing R&D risk. We also find that the decline in risk-taking is concentrated in operating accruals’ volatility.  Bank competition motivates lower borrowers' risk-taking through two mechanisms: (1) eroding borrowers' ability to commit to long-term relationship with banks, and (2) increasing the availability of cheaper credit. Further, risk reduction is more pronounced for firms that are more bank-dependent, smaller, less transparent, and receive cheaper loans after the regulatory reforms.

Keywords: bank competition, corporate risk-taking, investment

JEL Classification: G28, G32, G21