Informed equity ownership and bank loan contracting

Banks enter into loan contracts facing information asymmetries that demand costly due diligence and monitoring efforts. We hypothesize that enhanced monitoring could reduce information asymmetry and result in more favorable loan terms. We take local institutional ownership (IO) as a proxy for informed equity ownership that signals less information asymmetry and study the effect of informed equity ownership on creditors (bank loan contracting). We show that concentrated local long‐term institutional ownership (LLTIO) is associated with (1) a lower spread, (2) less stringent collateral requirement, and (3) less covenant intensity when shareholder–creditor conflicts of interest are unlikely and substituting monitoring devices are not in place. Our results are robust to controls for the endogeneity of IO. The findings suggest that the net effect from LLTIO's monitoring leads to more favorable loan terms and varies with the tradeoff in agency costs that creditors face.