Title: Effects of Corporate Distress on the Stock Prices of Lending Banks: An Empirical Study
Abstract: This paper examines the share price reactions of lending banks when their corporate borrowers encountered financial distress as reflected by loan defaults and/or margin trading announcements. The experimental sample is drawn from two types of financially distressed firms, 90 defaulted firms and 73 margin trading firms, respectively, over a 10-year period, 1996-2005. The empirical evidence indicates that news of corporate distress has a materially adverse impact on the stock prices of the main lending banks. Specifically, the news of loan default and margin trading by a corporate borrower accounts for an average decline of 3.741% and 3.174% for main lending banks' stock returns over an 11-day period around the date of default, respectively. In addition, the empirical results also show that bank exposure, distressed firms' bank debt, bank-firm relationships, and economic contraction have significant influences upon banks' abnormal returns around the announcement of corporate distress events. Introduction In recent years public and private enterprises in Taiwan have raised most of their money by means of direct finance; there has been an increase in the proportion of such enterprises ratio directly raising funds from the Taiwanese financial market with the growth rate of direct finance already surpassing that of indirect finance. According to Financial Statistics reported by the Central Bank in Taiwan, the ratio of the indirect finance was 76.07% (total to NT dollars 27,786 billion),1 and the ratio of the direct finance was only 23.93% (total to NT dollars 8,742 billion) at the end of January, 2008. In the aggregate, the importance of the indirect finance of financial intermediary activity is a twice as great as that of direct finance activity in which firms raise funds by issuing securities in the Taiwanese capital market. Furthermore, a survey of the financial conditions of public and private enterprises reports the external funding sources of Taiwan corporations account for 53% of the total funds. Among entirely external funds, the largest share (i.e. 40%) comprise loans from financial institutions,2 particularly from general commercial banks, for this reason, banks are of crucial importance for Taiwan's firms. Suggestively, the financial structure in Taiwan is much like a bank-based financial system. Hence, it is reasonable to expect that lending banks will be influenced when one of their borrowers is in financial distress. The aim of this paper is to investigate whether the distress news of a corporate borrower has an economic impact on its lending bank using Taiwan data, a subject that has attracted far less attention in emerging economies such as Taiwan than in already developed economies. Thus, this study collected data from Taiwan listed companies that had encountered financial distress over the 1996-2005-period to empirically analyze the lending bank's share price reaction when one of a bank's corporate borrowers entered financial distress as reflected by a loan default and/or margin trading. Our hypothesis is that the announcement of a borrowing firm's financial distress has a negative impact on a lending bank's stock returns in the heavily bank-dependent Taiwanese market. Except for the work of Dahiya, Saunders, and Srinivasan (2003), relatively few papers have focused on the bank's share price reaction when its borrowers suffer financial distress, particularly in an emerging market, like Taiwan, where firms tend to heavily depend upon bank loans. This empirical study attempts to contribute to the field in the literature. Our main findings are that both univariate tests and multivariate tests apparently demonstrate the negative cumulative abnormal stock returns for the main lending banks when corporate borrowers encounter financial distress. In particular, the effects of the news on the lending banks' share prices show a prior response that lasts even after the distressed event day. Moreover, we find that the bank exposure, distressed firms' bank debt, bank-firm relationships, and economic contraction potentially affect banks' abnormal returns around distress events. …
Publication Year: 2010
Publication Date: 2010-04-01
Language: en
Type: article
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Cited By Count: 1
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