Financial Reporting Quality and Dual-holding of Debt and Equity

In this dissertation, I examine the causes and consequences of investors’ simultaneous participation in a firm’s syndicated loan and equity (“dual-holding”). In the first chapter, I investigate whether the financial reporting quality of a firm is associated with investors’ dual-holding in that firm. Using hand-collected data on institutional investors’ loan and equity holdings from 2006 to 2014, I predict and find that investors are more likely to be dual-holders in firms with low financial reporting quality. Two possible explanations of this result are: (1) investors use dual-holding as a viable channel to gain access to better information in firms with low financial reporting quality and to make profitable trades in the firm’s equity based on material non-public information, thus extracting rent from other shareholders (“rent-extraction”), and (2) investors use dual-holding to mitigate the conflict of interest between shareholders and creditors that is exacerbated by the firm’s low financial reporting quality (“incentive-alignment”). Consistent with the rent-extraction hypothesis, I find that dual-holders achieve risk-adjusted abnormal annualized returns of approximately 6% in the borrower’s equity in the time period between the syndicate origination and the next quarterly earnings announcement. Contrary to the incentive-alignment hypothesis, I find that firms with dual-holders do not experience any improvements in their operating and market performance. In the second chapter, I analyze the consequences of investors’ dual-holding. I first examine how dual-holders influence the firm’s information uncertainty and disclosure environment. Using hand-collected data on lenders that simultaneously hold equity-position in the borrower, I find that dual-holders decrease the firm’s information uncertainty by causing the equity prices to adjust to firm-specific information more rapidly. Furthermore, consistent with shareholders’ increased scrutiny following dual-holder participation in a firm, I find that managers of such firms are more likely to issue earnings forecast following loan origination. Taken together, My findings have important implications for investors and policymakers and shed light on the importance of weighting the overall benefits versus the costs of informed-trading to the investors and capital market by the SEC and investors before enforcing insider trading rules and scrutiny of dual-holding institutions.Ph.D