Shareholder-Creditor Conflicts and Limits to Arbitrage: Evidence From the Equity Lending Market

46 Pages Posted: 14 Dec 2020 Last revised: 27 Jan 2022

See all articles by Yongqiang Chu

Yongqiang Chu

Belk College of Business, UNC Charlotte

Luca X. Lin

HEC Montreal - Department of Finance

Pedro A. C. Saffi

University of Cambridge - Judge Business School

Jason Sturgess

Queen Mary University of London

Date Written: January 23, 2022

Abstract

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

Chu, Yongqiang and Lin, Luca Xianran and Saffi, Pedro A. C. and Sturgess, Jason, Shareholder-Creditor Conflicts and Limits to Arbitrage: Evidence From the Equity Lending Market (January 23, 2022). Proceedings of Paris December 2021 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3747035 or http://dx.doi.org/10.2139/ssrn.3747035

Yongqiang Chu

Belk College of Business, UNC Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States
7046877695 (Phone)

Luca Xianran Lin (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Pedro A. C. Saffi

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom

HOME PAGE: http://www.pedrosaffi.com

Jason Sturgess

Queen Mary University of London ( email )

Mile End Road
London, London E1 4NS
United Kingdom

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