Information Spillovers and Cross Monitoring between the Stock Market and Loan Market: Evidence from Reg SHO

We explore information spillovers and cross monitoring between the stock and loan markets. To break simultaneity between the stock and loan markets, we use a regulatory experiment, Regulation SHO, that relaxes short selling constraints for a randomly selected sample of Russell3000 stocks, which directly affects information production and monitoring by short sellers in the stock market but is exogenous to the loan market. We find that while firms without bank monitors exhibit a significant decline in stock prices upon the announcement of SHO, firms with bank monitors do not react. Further evidence shows that firms affected by SHO enjoy a 21 basis point lower loan spread that increases to 36 basis points for bank-dependent firms. Regulation SHO, however, does not appear to affect non-price loan terms such as loan maturity, amount, collateral, and covenants. Overall, our evidence suggests bi-directional information spillovers and cross monitoring between the stock and loan markets. The effects on loan markets are consistent with a reduction in the information monopoly that banks possess over their borrowers. ∗Billett and Liu are with Kelley School of Business at Indiana University. Tian is with PBC School of Finance at Tsinghua University. We are grateful for the comments and suggestions from Gregory Udell and Chiyoung Cheong. We remain responsible for any errors and omissions.