Shareholder-Creditor Conflicts and Limits to Arbitrage: Evidence From the Equity Lending Market
45 Pages Posted: 14 Dec 2020 Last revised: 22 Nov 2021
Date Written: November 11, 2021
We show that conflicts of interest between shareholders and creditors affect prices in financial markets through the equity lending market and short selling constraints. Using mergers between financial institutions as exogenous variation in the presence of dual holders, that is, institutions holding equity and debt of the same firm, we find that shareholders increase equity lending supply when they face lower conflicts, which reduces short sale constraints and limits to arbitrage and increases price efficiency. The decrease in short sale constraints is more pronounced in firms with ex-ante greater conflicts of interest between shareholders and creditors. Our findings suggest that agency problems due to shareholder-creditor conflicts have a real impact on market efficiency and asset prices.
Keywords: Limits to Arbitrage, Dual Holders, Shareholder-Creditor Conflict; Short Selling, Equity Lending
JEL Classification: G21, G30, G34
Suggested Citation: Suggested Citation