Stress Test Failures and Mergers and Acquisitions

Abstract

Corporate borrowers of banks that failed stress tests subsequently conduct fewer mergers and acquisitions (M&A). The effect is stronger for treated firms with weaker corporate governance or more susceptibility to agency problems. We further document increased credit quality and financial covenant usage for M&A-related loans as well as improved borrower M&A deal quality after bank stress test failures, suggesting that such failures trigger enhanced bank screening on borrowers’ M&A projects. Moreover, by refraining from M&A that can hurt shareholders, treated firms improve their profitability. Our evidence highlights a novel, positive spillover effect of bank stress test failures on corporate M&A.

Keywords: Stress Tests, Mergers and Acquisitions, Bank Screening

JEL Classification: G21, G34