The Feedback Effect: Evidence from Bank Loan Pricing

We find that banks charge higher loan rates to the borrowers with higher short selling activities in their stocks. Exploring the 2007 change in short selling disclosure and the Tax Payer Relief Act of 1997 as quasi-natural experiments, we show that an increase (decrease) in the information content of short selling leads to a greater (smaller) impact of short selling on loan costs. Our results are stronger when the short selling costs are larger and the information asymmetry between the banks and the borrowing firms is greater. Our findings unveil a feedback effect between financial markets and bank lenders.