Institutional stock trading on loan market information

INSTITUTIONAL STOCK TRADING ON LOAN MARKET INFORMATION * Victoria Ivashina Harvard Business School Zheng Sun University of California, Irvine This draft: January, 2010 One of the most important developments in the corporate loan market over the past decade has been the growing participation of institutional investors. As lenders, institutional investors routinely receive private information about borrowers. However, most of these investors also trade in public securities. This leads to a controversial question: Do institutional investors use private information acquired in the loan market to trade in public securities? This paper examines the stock trading of institutional investors whose portfolios also hold loans. Using SEC filings of loan amendments, we identify institutional investors with access to private information disclosed during loan

amendments. We then look at abnormal returns on subsequent stock trades. We find that institutional participants in loan renegotiations subsequently trade in the stock of the same company and outperform trades by other managers and trades in other stocks by approximately 5.4% in annualized terms. Key words: Institutional investors, Syndicated loans, Insider trading JEL classification: G11, G14, G21, G22, G23 * Corresponding author: Harvard Business School, Baker Library 233, Boston, MA 02163. Phone: (617) 495-8018. E-mail: vivashina@hbs.edu . We thank Malcolm Baker, Josh Coval, Mihir Desai, Rob Engle, Ben Esty, Robin Greenwood, Joel Hasbrouck, Andre Perold, David Scharfstein, Erik Stafford, Phil Strahan, Guhan Subramanian, Peter Tufano, Robert Whitelaw, and seminar audiences at the 2008 American Finance Association Annual Meeting, the 2007 NBER Summer Institute, the 2007 European Finance Association Annual Meeting, the Securities and Exchange Commission, the Financial Industry Regulatory Authority, the Federal Reserve Bank of New York, Princeton University, Arizona State University and TCU for helpful comments. We are very grateful to Bill Simpson and Xiang Ao at the HBS Research Computing Services for helping us with statistical derivations, and to Magali Fassioto for excellent research assistance. 1. Introduction Loan syndication and the multiple financial innovations that have accompanied it have transformed the corporate lending market. Today, a large fraction of corporate loans are syndicated; in 2006 new corporate issuance of syndicated loans was over twice as large as total bond issuance and over five times larger than equity issuance. A syndicated loan is originated and monitored by one bank, yet it is funded by a group (or a syndicate) of lenders. An important fact about loan syndication is that most participants in lending syndicates are not banks but institutional investors, including collateralized loan 1 obligations, hedge funds, mutual funds, pension funds and insurance companies. It is estimated that in 2006 over 70% of high-yield loans in the United States, including leveraged buyouts and mergers and acquisitions financing, were held by institutional investors, up from under 30% in 1995. Overall, in 2006, there were 254 different non- bank investor groups participating in the syndicated loan market, amounting to 720 2 different investment vehicles. As a percentage of participants in the syndicated loan market, institutional managers have steadily increased from approximately 25% in the mid-1990s over 70% by the end of 2006. The availability of institutional funds allows banks to reduce their risk through diversification, improves loan-market liquidity and ultimately...

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