Information Production in Stock Markets and Cost of Bank Debt

This paper provides evidence that financing costs of firms are affected by information spillovers from stock markets. Specifically I show that the firms' bank borrowing costs are decreasing in measures of information production in stock markets. Extending the idea of information externalities of stock prices of Grossman and Stiglitz (1980), this paper tests the hypothesis that information reflected in stock prices should reduce the cost of bank loans for publicly traded firms since the bank can monitor the firm more efficiently by supplementing its own information with publicly available information such as stock prices. The empirical analysis is conducted in two stages: (i)assessing the impact of having publicly traded stock on a firm's borrowing costs, and (ii) cross-sectionally relating the degree of information production in stock markets to the borrowing costs. The empirical tests use data from two types of firms: private firms that go public (IPO sample) and public firms that go private (LBO/MBO firms). After controlling for firm risk, loan characteristics and sample selection issues, I find that the cost of bank borrowing is significantly lower for firms with publicly traded equity relative to private firms. The borrowing costs are also decreasing in proxies for the informativeness of the stock price.