Elsevier

Journal of Corporate Finance

Volume 33, August 2015, Pages 279-292
Journal of Corporate Finance

Family firms, soft information and bank lending in a financial crisis

https://doi.org/10.1016/j.jcorpfin.2015.01.002Get rights and content

Abstract

This paper studies differences in family and non-family firms' access to bank lending during the 2007–2009 financial crisis. The hypothesis is that the former's incentive structure results in less agency conflict in the borrower–lender relationship. Using highly detailed data on bank–firm relations, we exploit the reduction in bank lending in Italy following the crisis in October 2008. We find statistically and economically significant evidence that credit to family firms contracted less sharply than that to non-family firms. The results are robust to observable ex-ante differences between the two types of firms and to time-varying bank fixed effects. We show, further, that the difference is related to an increased role for soft information in some Italian banks' operations, following the Lehman Brothers failure. Finally, by identifying a match between those banks and family firms, we can control for time-varying unobserved heterogeneity among the firms and validate the hypothesis that our results are supply-driven.

Introduction

The global financial crisis of 2008 and the subsequent global recession made it clear that capital markets can be a major source of business cycle fluctuations1. Shocks to the banking sector are propagated to the real economy via reduced credit supply. In particular, a heightening of problems of asymmetric information in bank–firm relationships tends to amplify the shocks, affecting some types of borrower disproportionately (Bernanke et al., 1996). Problems of moral hazard (Holmstrom and Tirole, 1997) and adverse selection (Stiglitz and Weiss, 1981) tend to discourage lenders from supplying credit to firms with high agency costs. Information asymmetry is typically less severe for banks than for bondholders; while the latter must rely chiefly on publicly available information (balance sheets, ratings, etc. — so-called hard information), the former have access to “inside” information, which is transmitted through repeated interactions between the loan officer and the firm's manager (Diamond, 1989, Fama, 1985, Petersen and Rajan, 1994). Such information relates to the lending officer's subjective evaluation of the firm's creditworthiness and is commonly labeled as soft (Berger and Udell, 2002, Petersen, 2004). Soft information is an important determinant of corporate lending, especially to small businesses (Garcia-Appendini, 2011). In addition, it has been shown that soft information mitigates the repercussions of aggregate credit contractions (De Mitri et al., 2010, Jiangli et al., 2008). The reason is that hard information, such as past performance and standardized risk measures, are less reliable in predicting firm risk profiles during a crisis. Soft information about a firm's current results and future plans, which is continuously updated and better targeted to the characteristics of the borrower, can reduce such uncertainty.

Yet despite the academic interest in the importance of soft information in banks' lending decisions, it is still unclear which types of firm benefit most from an established banking relationship. We address this issue by focusing on the heterogeneity in firms' ownership structure, namely the presence or absence of a family block-holder. In particular, we pose an empirical question: does the presence of a family block-holder mitigate bank–firm agency conflicts during a financial crisis? The answer is closely related to differences in the incentive structures of family and non-family firms, hence to the banks' potential risk-shifting problem (Jensen and Meckling, 1976).

Burkart et al. (2003), and more recently Bandiera et al. (2012), have observed that family block-holders attach a value to control that is not merely monetary but also comprises an amenity component, i.e. utility gained from the control per se. This amenity component can be thought of as the personal status acquired thanks to the identification of the family name with the firm or the desire to pass the firm on to descendants. This translates into higher non-monetary costs of default, which reduces the incentive for strategic default (Anderson et al., 2003). On the other hand, as is pointed out by Villalonga and Amit (2006), Ellul et al. (2009) and Lins et al. (2013), family block-holders may have more incentive to extract private benefits at the expense of the other shareholders and stakeholders generally2. In contrast to the case of non-family block-holders, the gains from misconduct are concentrated in a single family group.

In a financial crisis, the lower expected return on investments can aggravate the incentive to divert resources out of the company, reducing a family firm's investment in the future and decreasing the probability that it will repay its debt. On the other hand, family firms may be perceived as more creditworthy because they have less incentive to default in the future. The evaluation of the overall impact of family ownership on credit allocation thus depends on the relative numbers of “good” and “bad” family and non-family firms. Therefore, even if the family status of firms is observable to all banks, only soft information gathered through personal contact with firms' managers can enable a loan officer to assess whether — for the same publicly available characteristics — a family firm is more creditworthy than a non-family one. In other words, soft information supplements hard information by revealing the possibly different objective functions of family and non-family firms.

We answer our empirical question on the basis of highly detailed data from the Italian Central Credit Register (CCR), which covers all loans to non-financial firms by banks operating in Italy. These data are matched with firm-specific data, including family ownership status. Here we are able to include family firms of different sizes, including small and medium-sized enterprises (SMEs), for which detailed information on corporate structure is not ordinarily available. We cover the period from 2007 to 2009, so that we can compare results before and after the Lehman Brothers bankruptcy. The choice of October 2008 as the watershed date reflects the nature of the shock represented by the Lehman Brothers failure. This event was exogenous and largely unexpected by Italian banks, and prompted a decreased propensity to lend (Albertazzi and Marchetti, 2010). At the same time, the direct asset losses that hit the banking sector in many OECD economies were not a major concern for Italy (or for Japan), where banks concentrate more on traditional credit activities (Panetta et al., 2009).

For the purpose of our analysis, Italy represents an ideal laboratory. First, bank lending is by far the most important type of debt for both the family and the non-family firms in the sample (85% of total debt). Moreover, there was substantial heterogeneity in the banks' use of soft information in the wake of the crisis. A survey conducted by the Bank of Italy in 2009 indicates that, as a result of the financial crisis 35%, of the banks surveyed (representing 36% of total aggregate credit) increased the relative weight, in lending decisions, that they attached to qualitative information and direct knowledge of the borrower.

The empirical analysis reveals that the aggregate growth rate of loans was lower, one year after the failure of Lehman Brothers, for both family and non-family firms. But for family firms the contraction was about 5 percentage points less severe and the difference was statistically significant. This result is robust to the inclusion of a rich set of observable characteristics to control for the correlation of family ownership with other firm characteristics. By exploiting the presence of multiple lending relationships, we also control for time-varying bank fixed effects. This differential effect does not depend on the nationality of the controlling shareholder, on group affiliation, or on concentration of share ownership. We find no differences between family and non-family firms in interest rates or the amount of collateral (see the Appendix). These findings can be read to mean that, other things being equal, the existence of a family block-holder reduced banks' expected default risk. Given that on average family firms are smaller, this alternative flight-to-quality mechanism favoring family firms is consistent with the findings of Presbitero et al. (2012) who show that in the 2007–2009 financial crisis smaller firms in Italy suffered a less severe contraction in credit availability than larger ones.

Using the information on bank lending practices from the Bank of Italy survey, we further show that the banks that increased their reliance on soft information accounted for the observed difference between family and non-family firms. Starting from this, we estimate a time-varying firm-fixed-effect model, interacting a family firm dummy with an identifier of banks that increased such reliance in their lending decisions. This empirical strategy controls for unobserved heterogeneity between firms (e.g. demand shocks) and enables us to validate the hypothesis that results are driven by changes in credit supply. The results suggest that those banks that increased their reliance on soft information tended to re-allocate credit towards family firms.

Our results are important in two ways. First, family firms are common all over the world among SMEs, but also among listed corporations (Bertrand and Schoar, 2006).3 So their access to financial markets is potentially a significant factor in the performance of the economy, insofar as financially constrained firms tend to lower investment and employment levels (Campello et al., 2010), aggravating the impact of credit supply shocks.4 Accordingly, in the last section of the paper we examine the extent to which differing access to bank credit is mirrored in differences in firm performance from 2007 to 2009. We find no significant differences in capital expenditure, but we do find substantial differences in the employment policies of family and non-family firms, the former reducing their workforce by 2.6 percentage points less. Finally, profitability, as measured by the ROE, declined less in family firms. Taken together, these findings suggest that the credit re-allocation towards family firms had significant economic effects, and it appears to have been efficient for the banking system. Second, the study contributes to the debate on the efficiency of relationship lending. In the last two decades, hard information has played an increasingly important role in lending practices, owing both to regulatory pressure and to the spread of information technology in the financial industry. Our findings indicate that soft information can mitigate the negative effects of an aggregate credit contraction, constituting a valuable resource for banks at times of uncertainty.

The rest of the paper is organized as follow: Section 2 presents the data and gives some descriptive statistics of the sample firms; Section 3 analyzes the dynamics in loans granted, showing how they differ between family and non-family firms; Section 4 examines bank–firm relationships, focusing on the interaction between soft information and family firm status; Section 5 documents the differences in real outcomes between family and non-family firms, and Section 6 concludes.

Section snippets

Data sources and descriptive statistics

In this paper we exploit information on bank–firm relationships, corporate governance, balance sheets and bank organization. Accordingly, our dataset comes from four main databases: Invind, Cerved, Central Credit Register (CCR) and a special survey of Italian banks conducted by the Bank of Italy in 2009. Each single observation consists of a firm–quarter–bank triplet; the observations cover the years 2007–2009.

The Invind survey is conducted yearly by the Bank of Italy (Survey of Industrial and

Bank lending and corporate ownership

This section investigates whether the amplitude of the contraction in bank lending to firms was related to their ownership structure. In addressing this empirical question, we look first at the firms' overall exposure to the banking system, gauged by the total volume of credit lines they have. We aggregate all the data from each firm's banking relationships into a single observation.

Heterogeneity among banks in lending practices

In the previous section, controlling for an ample set of observable characteristics, hence conditioning on hard information, we observed that the credit contraction that followed October 2008 was significantly less severe for family firms. This is consistent with the hypothesis that additional soft information, acquired through the personal interaction of loan officers with firms' managers, played a substantial role in explaining the difference.19

Investments, employment and economic performance

In this last section we analyze the economic effects of the financial crisis to detect possible differences between family and non-family firms in the years from 2007 to 2009. Our results tie in with the growing body of literature since the financial crisis on the effects of bank lending shocks on the real economy. Columns (1) to (4) in Table 8 take as dependent variable the log difference in physical capital expenditures, intangible asset investment, number of employees and average wage. In

Conclusions

We have studied the credit allocation decisions of Italian banks following the Lehman Brothers failure in October 2008 in relation to differences in borrowing firms' ownership structure. We have verified that ownership is an important source of heterogeneity among firms. In particular, the presence of a family block-holder had a positive effect in attenuating the agency conflict in the relationship between borrowers and lenders. This effect was closely related to the increased use of soft

Data construction

The CCR database records all the loans granted by Italian banks above a set reporting threshold. The threshold applies to the sum of all credit granted to an individual firm by a bank in three main categories:

  • 1.

    short-term lines of credit (analyzed in this paper),

  • 2.

    collateralized credit lines, mortgages, etc.,

  • 3.

    advances, etc.

The reporting threshold has changed over time: it was lowered from 75,000 to 30,000 in September 2008. For missing CCR observations we proceed as follows:

  • when an observation for a

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    An earlier version of this paper circulated under the title “Family Firms and the Agency Cost of Debt: The role of soft information during a crisis”. The views expressed are those of the authors and do not involve the responsibility of the Bank of Italy or Confindustria. We thank Mario Daniele Amore, Arpad Abraham, Jerome Adda, Alastair Ball, Elena Carletti, Vittoria Cerasi, Marco Cucculelli, Luigi Guiso, Anais Hamelin, Andrea Ichino, Giuseppe Ilardi, Steven Ongena, Marco Pagano, Nicola Pavoni, Jun Qian, Giancarlo Spagnolo, Hannes Wagner and an anonymous referee for their insightful comments. We also thank participants at: Journal of Corporate Finance Special Issue Conference on Family Business Renmin University Business School, June 2013; Workshop on SME finance University of Strasbourg, April 2013; Workshop on Italian bank lending Bank of Italy, March 2013; CSEF seminar, November 2012; EIEF seminar, October 2012; Workshop on Institutions, Individual Behavior and Economic Outcomes, September 2012; EUI Forum, May 2012. All remaining errors are our own.

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