Shareholder-Creditor Conflicts and Limits to Arbitrage: Evidence From the Equity Lending Market
46 Pages Posted: 14 Dec 2020 Last revised: 27 Jan 2022
Date Written: January 23, 2022
We show that conflicts of interest between shareholders and creditors affect prices in financial markets through the equity lending market and short sale constraints. Using the presence of dual holders -- institutions holding equity and debt of the same firm -- as a proxy for reduced shareholder-creditor conflicts, we find that shareholders increase equity lending supply when they face lower conflicts. We exploit exogenous variation in dual holder presence induced by mergers between financial institutions to establish causality. Dual holder presence hence reduces short sale constraints and limits to arbitrage, leading to less overpricing. Shareholders of firms with dual holders are also less likely to recall loaned shares prior to voting events to exercise control rights. 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