Equity Short Selling and the Bank Loan Market

Using a difference-in-differences approach, we show that relaxation of short-sale constraints helps to filter out low-quality borrowers from the bank loan market. Treated firms that can still borrow from banks enjoy a lower loan spread, compared with control firms without this sorting mechanism. The results show that such treated borrowers have improved information asymmetry and credit risk, as well as better nonprice contract terms. Overall, equity short selling has a real effect on the bank loan market by weeding out poor-quality borrowers, resulting in a lower cost of private debt for remaining borrower firms.