Stock Price Fragility and the Cost of Bank Loans

Abstract

This study examines whether the flow volatility experienced by institutional investors affects firms’ financing costs. Using Greenwood and Thesmar’s (2011) stock price fragility, a proxy for firm exposure to its institutional investors’ flow volatility, we find that firms with high stock price fragility pay higher bank loan costs than firms with low fragility. This effect on cost is partially mediated through board monitoring and most pronounced when lenders rely more on institutional shareholders to discipline corporate management, suggesting that unstable flows might weaken institutional investors’ monitoring effectiveness. The paper adds to the evidence that non-fundamental risks (institutional investors’ flow shocks) can have real impact on firms.

Keywords: Stock Price Fragility, Flow Volatility, Bank Loan Cost, Non-Fundamental Risk

JEL Classification: G12, G21, G32